[Asia Economy Reporter Eunbyeol Kim] As climate change phenomena increase unexpected natural disaster damages such as monsoons, cold waves, and wildfires, there is a growing call for South Korea to shift toward mandating disaster insurance enrollment.
On the 6th, Jeong Gi-young, Director of the Financial Stability Bureau at the Bank of Korea, stated in the 'BOK Issue Note - Current Status of Domestic and International Disaster Insurance Systems and Improvement Tasks for Climate Change Response' that "to enhance disaster damage compensation and insurance operation efficiency, it is necessary to transition disaster insurance enrollment from a voluntary to a mandatory system." Since immediate mandatory enrollment is difficult, Jeong proposed prioritizing disaster insurance enrollment for high-risk groups and gradually expanding it to medium- and low-risk groups in the future.
Disaster insurance is not only a risk management tool to compensate for disaster damages but also has a public assistance nature where the government and policyholders share disaster losses. Major countries such as the United States, the United Kingdom, and France have operated disaster insurance systems since the mid-to-late 20th century to prepare for large-scale disasters like floods and earthquakes. Because disaster insurance faces issues such as adverse selection and moral hazard more than other insurance products, major countries involve the government and public sector to some extent in disaster insurance operations.
In South Korea, disaster insurance is operated separately for crops and livestock (Ministry of Agriculture, Food and Rural Affairs), aquaculture products (Ministry of Oceans and Fisheries), and wind and flood damage (Ministry of the Interior and Safety). However, since enrollment is not mandatory, the subscription rate is generally low, and mainly high-risk groups enroll, limiting the risk diversification effect of the insurance. The premium calculation method based on past disaster damage cases (experience rating) fails to reflect actual disaster risks, and the differential premium rate system is generally simple.
Jeong stated, "Since natural disasters can cause direct asset value losses and economic activity decline, disaster insurance is important from a financial stability perspective as it mitigates the spread of physical risks from climate change to the financial sector." He added, "Considering climate change trends, the experience rating system may not adequately reflect the possibility of intensified natural disasters in the future, potentially resulting in premiums being set lower than appropriate levels."
He also noted that since problems such as temporary adverse selection intensification may arise during the mandatory enrollment of high-risk groups, institutional improvements to strengthen enrollment incentives for medium- and low-risk groups should be implemented simultaneously.
Jeong further suggested introducing catastrophe bonds as a risk diversification tool for private insurers. Catastrophe bonds are bonds issued to transfer disaster insurance payment risks to the capital market. If a disaster meeting the conditions set at the time of bond issuance does not occur, bond investors can earn investment returns. If the conditions are met, the insurer issuing the bonds uses the bond proceeds as funds for insurance payments, and investors receive the remaining assets after insurance payments.
Jeong pointed out, "Generally, the issuer of catastrophe bonds is not the insurer selling disaster insurance but a special purpose vehicle (SPV) established by the insurer." However, under current regulations, insurers (or reinsurers) need approval from the Financial Services Commission to establish and operate an SPV, making procedural transaction costs higher than the benefits of bond issuance." He added, "The approval system for establishing SPVs for catastrophe bond issuance should be relaxed to a notification system, and the establishment requirements and procedures should be simplified."
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