Abstract
In the past few years, the insurance community has paid increasing attention to the “protection gap”—the extent to which significant losses are not covered by insurance. The Geneva Association, the insurers’ global think tank, has pioneered the concept, and it has become widely adopted.
Insurance always presents gaps in coverage; not all risks are insured or indeed insurable. The protection gap concept necessarily embodies a normative component—that insureds with limited coverage, potential insureds who lack insurance, and society as a whole suffer when certain gaps in insurance exists. It is this normative component of the protection gap concept that has not been fully developed and is the subject of this article.
Part I of the article explains the commonly used definitions of the protection gap. The most commonly used definition—the “risk protection gap”—is purely empirical, measuring the difference between total losses and insured losses. Analytically superior but harder to operationalize is the “insurance protection gap,” which is the difference between the amount of insurance that is economically beneficial and the amount of insurance in place. The insurance protection gap properly introduces a normative element to the concept, but it does not capture all of the considerations at stake. Part I offers a different definition: In a particular context, the protection gap is the difference between the amount of insurance that is in place and the amount of insurance that should be in place.
Part II of the article expands on the definition and discusses how much insurance “should be” in place. The method begins by defining a particular insurance context and then constructs policyholder expectations in that context. To define a baseline against which a protection gap should be measured, however, policyholder expectations must be reasonable. Therefore, the risks at issue must be insurable, the insurance must not be undermined by other effectiveness issues, and the social effects of coverage or its absence must be taken into account.
Part III illustrates how the article’s definition of the protection gap can be applied by analyzing several issues in homeowners insurance. A major problem, and a clear instance of the protection gap, is the extent to which homeowners frequently are underinsured for their losses. The most frequently discussed protection gap involves disaster losses, so this part applies the analysis to flood losses. The part concludes by considering whether several more mundane issues constitute protection gaps, damage caused by rain runoff, and matching of damaged and undamaged property.