Insurers are on the front lines dealing with increases in frequency and severity of natural catastrophes in the wake of climate change.
- Meg Green
- December 2019
Global temperatures. Water levels. Insurance claims.
All are rising, due to climate change, an issue that has the potential to touch every aspect of the insurance business.
As the Earth's climate continues to change, the size and frequency of natural catastrophe claims are increasing. Property/casualty insurers and reinsurers are bracing for more frequent flooding, wildfires and stronger hurricanes. Life/ health insurers face increased risks of infections and diseases, pollution and the struggle to have adequate clean water, according to Swiss Re.
The fourth-warmest year of all time.
Source: Munich Re
Insurers face increased regulation and legislation, higher claims and challenging underwriting, plus increased pressure to mitigate risks where possible and to close the “protection gap”—the difference between those covered by insurance and those who are not.
While insurers say climate change is a slow-moving force, today they are dealing with it on two fronts: underwriting and investments.
“It's impacting the industry. That's really changing the nature of overall risk,” said David Priebe, chairman of Guy Carpenter.
The Frog in the Pot
2018 was the fourth-warmest year of all time, continuing a series of record years. All 18 years since 2001 rank among the 20 warmest since measurements began, according to Munich Re.
“Our job is to analyze data on longtime series, and where we see changes when it comes to the climate, is that over the last hundred years or so, the world has warmed up by somewhere in the order of one degree centigrade, both the atmosphere, and also the sea surface,” said Ernst Rauch, head of climate and public sector business development for Munich Re.
Climate change is “having potentially significant implications on parts of our balance sheet, on the asset and liability sides.”
From an uptick in wildfires in California to more drastic monsoons and heat waves in Asia, climate change is being blamed for influencing severe weather trends around the world.
Global insured losses from natural catastrophe events in 2018 were $76 billion, the fourth highest on Swiss Re records. The combined insurance losses from natural disasters in 2017 and 2018, soared to $219 billion, the highest-ever for a two-year period, Swiss Re said.
Insurers are grappling to accurately estimate future losses. Catastrophe models have come under fire for not always being accurate.
“[It] looks like the catastrophe activity is getting more severe, more frequent. We need to be comfortable as an industry that these models are properly assessing this risk at the end of the day,” said Kathleen Reardon, chief executive officer of Hamilton Re.
What this means to those who “put a price tag on these risks,” is they can no longer rely solely on the data from the past, Rauch said. But understanding the impact of a changing environment is a challenge.
“Changes with respect to probabilities of certain extreme weather events occurring, they don't happen overnight,” Rauch said. “It is not the case that on a year-by-year basis, the probability of a tropical cyclone or hurricane occurring is by a factor of x higher or so. These are slow changes.”
Insurers' views of catastrophes are evolving, said Frieder Knüpling, group chief risk officer with Scor.
Climate change is “having potentially significant implications on parts of our balance sheet, on the asset and liability sides,” Knüpling said. “We invest a lot in trying to understand the implications of climate change on our loss exposure and our key natural catastrophe exposed areas. We make significant investments on our modeling capabilities. We've tried to factor in climate change trends as diligently and as quickly as necessary in order to avoid that we underestimate the speed of climate change. It means that our views on those big exposures are evolving. They are evolving quite rapidly, which has important implications in how we look at the adequacy of pricing of certain exposures which are important for us.”
Major catastrophes, like hurricanes and earthquakes, may dominate news coverage, but the total costs of natural disasters, amounting to $155 billion in 2018 alone, are increasingly driven by smaller recurring events known as secondary perils, Swiss Re said.
Primary perils are events that are low frequency but high severity such as hurricanes, cyclones and earthquakes. But more than 60% of the 2017 insured losses, and more than 50% of the 2017-2018 losses, stemmed from so-called “secondary” perils: independent, high-frequency events, such as severe thunderstorms, river floods, drought and wildfires—all on the rise due to climate change, according to Swiss Re.
So what's an insurer to do?
Insurance companies can’t just keep charging more and more money as the risk increases.
“It's a little bit like the situation with the frog which swims in a pot of water, and the pot is on the stove. When you turn on the stove, the water warms up, and the frog doesn't realize that the threat to him is increasing with the warmer water. Once the water starts boiling, it is too late for the frog,” Rauch said. “What I'm saying is that it is a challenge that slow-onset changes driven by climate change, change in probabilities on a year-by-year basis are not easy to really translate into markets.”
Challenges Bring Opportunities
One opportunity some insurers see is the increased emphasis on closing the “insurance gap,” the gap between insured losses and uninsured catastrophe losses. The Swiss Re Institute puts the figure of the global protection gap at $280 billion in the last two years alone.
A solution to closing the gap is increased use of public/private partnerships, said Simon Konsta, senior partner with attorneys Clyde &Co.
“Nobody's actually grappled with something like climate change before,” Konsta said. “There are insurance solutions.”
He suggested the enhanced use of parametrics, whether in the growing resilience bond product or in an insurance product, might help countries manage increased natural catastrophe risks.
Another potential solution is microinsurance, said Shaun Tarbuck, president and CEO of the International Cooperative and Mutual Insurance Federation. But these small policies with tiny premiums offered in Third World countries haven't always delivered the protection promised, he said, because getting people to buy into the coverage is still challenging.
“Microinsurance hasn't done what it should have done, which is taking protection insurance to the masses,” Tarbuck said. “It's ticked a few boxes, but unfortunately, most of those are ones you wouldn't call successful because they haven't actually done the education piece.”
John Huff, CEO and president of the Association of Bermuda Insurers and Reinsurers, said the protection gap isn't just about emerging markets.
“The best example in the United States is flood insurance, which is an optional product in the U.S.,” Huff said.
The number of global insurers who have enacted formal coal insurance restrictions and associated divestments across their investment portfolios.
Source: Institute for Energy Economics and Financial Analysis
An all-perils policy could remedy this, Huff said. “Should everything be covered so consumers don't have to pick a menu of whether they're going to be covered for wind, tornado, hurricane, earthquake and flood? Really, an all-perils policy that is truly a full protection product. That would come with a cost. But if it were uniform coverage it would be cheaper for all than if there were certain markets with just that coverage.”
Mitigating the Loss
Insurers are also looking at how to lessen claims before they happen.
“We need to have a much more robust conversation about how we can prevent losses and help communities to become much more resilient and storm-resistant or resistant to wildfires, instead of just paying for the losses after they occur,” said David Sampson, CEO and president of the American Property Casualty Insurance Association.
One example: the Institute for Business and Home Safety found that a fire-mitigated house can now be built for roughly the same cost as a regular house, said Lara Mowery, head of global property, specialty at Guy Carpenter.
This has the potential to be a game changer. Losses from wildfires added up to $5.1 billion over the past 10 years, IBHS said, with 4.5 million U.S. homes identified at high or extreme risk of wildfire—more than 2 million in California alone.
Nobody’s actually grappled with something like climate change before. There are insurance solutions.
Clyde & Co.
“Their research shows, absolutely, that taking some pretty simple steps—the kinds of siding that you choose to use, the way you choose to build your deck, what you use for landscaping around your house—has an incredible impact on your house's ability to withstand an event or to respond positively in an event,” Mowery said.
In areas most at risk for wildfire, the IBHS found every $1 spent in mitigation can reduce $3 in future losses.
“Insurance companies can't just keep charging more and more money as the risk increases,” Mowery said. “We've got to find ways to address the risk in ways that reduce the amount of dollars in those losses.”
Dirty, Dirty Coal
Coal is considered the dirtiest fossil fuel, and carries the bulk of the blame for the man-made factors contributing to climate change. Regulators—and public opinion—are putting pressure on companies to distance themselves from the coal industry.
Insurers are announcing they are stepping back from insuring or investing in the coal industry on a regular basis.
As of October, 29 global insurers have enacted formal coal insurance restrictions and associated divestments across their investment portfolios, according to the Institute for Energy Economics and Financial Analysis.
Axis Capital announced a new policy Oct. 16, saying it won't provide new coverage for the construction of new thermal coal plants or mines, or to companies that rely on coal for 30% or more of their revenues. Also, the company said it won't make new investments in companies that rely on coal for 30% more of their revenue.
“We believe insurers have an important role to play in mitigating climate risk and transitioning to a low-carbon economy,” Albert Benchimol, CEO of Axis Capital, said in a statement announcing the decision.
“You're starting to see some corporate activism, joining social activism, to try to raise the visibility of the urgency of climate change,” Benchimol said during an interview in September.
Losses from wildfires over the past 10 years.
Source: Institute for Business and Home Safety
In August, Chubb U.S. became the first U.S. insurer to announce a formal coal exit policy. At the time, Chairman and CEO Evan G. Greenberg said the company enacted the policy recognizing “the reality of climate change and the substantial impact of human activity on our planet…. The policy we are implementing today reflects Chubb's commitment to do our part as a steward of the Earth.”
Call to Purpose
But no matter how the world's environment, and the frequency and severity of natural catastrophes continue to evolve, “we as an industry are going to be there when natural disasters hit,” said Sampson. “We want to help individuals and communities get back on their feet again. One of the real value-adds that we believe the industry can play is bringing all of our resources and research together to help communities become much more resilient.”
Huff of ABIR said the timing of the insurance industry focusing on climate change “has never been better.”
“There's unprecedented capital and capacity available in the market at the same time the government need protection, and they're really under pressure for their own budgets,” Huff said. “It's really a new era, if you will, in protecting communities and governments, municipalities and states.”