IMPACT OF EXTREME EVENTS ON THE INSURANCE MARKET IN GHANA

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CHAPTER ONE INTRODUCTION

            Background of Study

Extreme events have long been the focus of atmospheric sciences and have raised considerable concern of the public, policy makers and scientists because of their significant social and economic impacts. According to Stephenson (2008), extreme events are relatively difficult to define even though they are generally easy to recognize. However, Stephenson (2008) defines extreme events as events that have extreme values of certain important meteorological variables, such as, large amount of precipitation (e.g. flood), high wind speeds (e.g. cyclones) and high temperatures (e.g. heat waves). Task Team on the Definition of Extreme Weather and Climate Events (TT-DEWCE) (2016) further defines an extreme event as any event with high economic loss. Extreme event is also seen as a severe event with low probability of incidence but potentially high associated sicknesses, mortality or economic loss (Siri, Newell, Proust, & Capon, 2016). Extreme events include not only meteorological (extreme temperature, floods), but climatological (drought, famine), geological (earthquakes), epidemiological (epidemic), and anthropogenic (terrorism, fire) events. Various processes give rise to extreme events and according to Stephenson (2008), the movement of a weather system into a new spatial location or into a different time period and the simultaneous coincidence of several non-extreme conditions can cause extreme events. Also, slower disparities in the climate system causing persistence or frequent recurrence of weather can lead to recurring extremes.

Extreme events cause both direct and indirect damages to economies and individuals. Direct damages can be seen as the loss of life, injury, damages to raw materials, capital and other fixed assets as a result of these events. Indirect damages include loss of productivity and

income due to the destruction of resources (Cavallo & Noy, 2009). Droughts, floods, windstorms, extreme temperatures, wildfires and epidemics have caused about 8,835 disasters, 1.94 million deaths and US$ 2.4 trillion of economic losses globally from 1970 to 2012 (WMO, 2014).

The frequency of extreme weather events rose from 38 in 1980 to 174 events in 2014 globally which is more than 400 percentage increase (Müller-Fürstenberger & Schumacher, 2015). The rise in the severity and occurrence of extreme events can be attributed to urbanization of the population, growing population intensity and assets in risky areas, and the possible impact of climate change (global warming) (Kunreuther & Michel‐Kerjan, 2009; Cummins & Mahul, 2009). Increase losses from extreme events for the past 20 years have made developing countries particularly helpless since they depend highly on agriculture, lack adequate resources to prepare and respond effectively to emergency (Courbage & Mahul, 2013).

According to the report from the UNDP (2013), Ghana’s main exposure to extreme events is flooding, epidemics, wildfires and drought. Ghana has experienced 29 disasters over a 30 year-period from 1980 to 2010. Of the 29 disasters, 14 were epidemics, 13 were floods and there was one each of drought and wildfire (Disaster and Risk Profile:Preventionweb, 2017). In 1983 Ghana experienced a drought which affected 12.5 million people. In June 1995, the entire city of Accra was flooded leaving about 70 people dead. Again, in 2007 the Upper East, Northern, Upper West, and some parts of the Western regions experienced massive floods causing the death of about 56 people and affecting about 332,600 people (Boah- Mensah, 2017). The most recent disaster which hit the country hardest was the June 3rd, 2015 flood and fire disaster. More than 200 lives and several properties were destroyed as a result of the disaster (Boah-Mensah, 2017).

  •     Statement of the Problem

Insurance is one of the main ways in which societies currently deals with the risks of extreme hazards, such as windstorms and floods as well as the losses associated with them (UNEP FI, 2014; Linnerooth-Baye & Mechler 2009). According to Coomber (2006), insurance price and diversify risk faced by the society, and its capital base is used to partially absorb the impact of unavoidable shocks. There are various ways in which insurance provides assistance for the loss of assets, incomes and lives due to extreme events. Right after a disaster, individuals are indemnified and restored back to their original financial position before the loss. This aids in protecting the livelihood of individuals and preventing business interruptions. Also, government is able to finance the loss associated with these events and avoid fiscal deficits (Schäfer, Waters, Kreft, & Zissener, 2016: Linnerooth-Baye & Mechler, 2009). Though the global losses from a disastrous event cannot be prevented by insurance, by paying a small amount of premium those at risk can be protected against a large loss which can adversely affect their finances (Kunreuther & Michel-Kerjan, 2007).

The Intergovernmental Panel on Climate Change has predicted an increase in the risks associated with extreme events as the global mean temperature rises (IPCC, 2014). This is likely to cause a significant surge in losses in the coming years, increasing the vulnerability of developing countries to extreme events and so, the role of insurance is very crucial. However, insurance is practically very low in developing countries even though they bear a greater percentage of the burden, in terms of both casualties and direct economic damages (Linnerooth-Bayer & Mechler, 2007; Lester, 2009; Cavallo & Noy, 2009). Cummins and Mahul (2009) in their book made known that developed economies mostly use compulsory insurance to cover about 40 percent of the direct losses from natural disasters. On the contrary, less than 10 percent of these losses are covered by insurance in middle-income countries and less than 5 percent in low-income countries.

Due to the lack of insurance cover, rebuilding after an extreme event may be delayed and may negatively impact economic growth in developing countries in the long run. To ease their burdens, governments of developing countries, such as Ghana, are promoting insurance as one of the key ways of financing extreme events risks (Ghana National Climate Change Policy, 2012). Currently, insurance markets in developing economies are growing rapidly even though they account for only about 16 percent of the global insurance market (International Financial Corporation, 2016). The question therefore is, whether extreme events can affect the growth and sustainability of the insurance market especially in developing countries, and if so, what mechanisms of demand and supply reactions comprise the effect. Furthermore, how will extreme events affect the industry’s ability to cover future losses? A study by Turner and Deng (2015) shows that a striking risk of high intensity from a major event could raise risk awareness and therefore increase insurance demand. On the supply side, the depletion of capital reserves by a major loss can intensify competition among insurers, prompting some to exit the market. The remaining insurers raises their premiums, with the hope of recouping some of their losses, which ultimately becomes higher than what policyholders are prepared to pay. This could affect the supply of insurance for people and their properties (Herweijer, Ranger, & Ward, 2009). Although insurance connects the world through risk-sharing agreement, the major objective of insurance companies is to make profits for shareholders. However, the growing exposures and intensities of risk due to extreme events increases insurers’ capital requirements and challenge their profitability and insurability (Coomber, 2006). Insurance companies keep reserves, capital and financial assets to pay claims as and when they occur. Insurers invest part of their capital in equities and property, in many cases, and they may be negatively affected by extreme events due to climate change. Also, an upsurge of extreme events may cause regulatory capital required to

increase. Assets are also likely to fall in value as the liabilities and capital requirements are rising and this may eventually affect the profitability of insurers (Maynard, 2008).

Therefore, analyzing the insurability of risk (supply of) and demand for insurance, especially in developing countries like Ghana, post extreme events and their influence on the profitability of insurers is necessary to develop a broad picture of the extreme event risk problem and evaluate feasible solutions.