Is the industry strong enough to cope with $40bn-plus weather losses every single year? Helen Yates presents the results from GR’s latest survey on insuring climate change

How can the industry prepare for the risks of tomorrow? Scientists, catastrophe modellers, underwriters, risk managers and politicians are in agreement that the risk of weather-related catastrophes is increasing. Aside from the occasional sceptic, most accept that insurers and reinsurers have an incredible challenge on their hands.

Ahead of a major industry conference in London – Insuring Climate Change – hosted by Global Reinsurance and its sister publications Insurance Times and Catastrophe Risk Management, we conducted our most extensive survey yet. Of those 125 insurance, reinsurance and risk management professionals who took part, a staggering 84% said they were concerned about the economic consequences of climate change.

It has been a year of widespread flooding (UK, Australia and China), heat waves and forest fires (Western Europe and California), intense hurricanes and typhoons, winter storms and freak weather events (tornadoes in Florida and a cyclone in Oman). Sixty-two percent said they thought summer flooding events in the UK were yet more evidence of climate change. Others disapproved of using individual events as evidence of climate change, saying wider trends were more accurate.

The World Meteorological Organization and the UN Intergovernmental Group on Climate Change have noted an increasing trend in extreme events over the last 50 years. They say it is “very likely” that hot extremes, heat waves and heavy precipitation events will continue to become more frequent.

Our survey respondents agree. Given a list of different perils forty-three percent said heavy precipitation was most likely to be exacerbated by climate change. Eighteen percent opted for windstorms while 10% went for bush fires and heat-related hazards. Several respondents insisted all perils would be affected. “The impact will be relative to the location and cannot be considered in such a simplistic way,” said the CEO of a climate risk management company.

“By mandating higher premiums for those living in catastrophe-exposed parts of the world, there is often political fallout

Paying for the risk

While 53% agreed that homeowners living in peak zones should pay for the risk, only 18% said they thought they were paying the right premiums. “Should price reflect risk: yes. Will price reflect risk: no. Why? Because continued and constant pressure to maintain market share will drive prices, as will easier and more frequent access to the capital markets via securitised risks,” concluded one reinsurance broker. Dan Ozizmir, head of insurance-linked securities at Swiss Re disagrees. “Securitised risks reflecting capital market pricing are the appropriate price for the risk,” he says.

Of course, by mandating higher premiums for those living in catastrophe-exposed parts of the world, there is often political fallout. In Florida, for example, the recent “socialisation” of insurance, as some call it, was a direct response to rate hikes following active storm season in 2004 and 2005. “The insurance industry is very bad at PR,” accused a senior UK government official. “In these cases, we really need to get the message across that insurance isn’t a ‘right’ but a commercial product. At the moment, the insurance industry is seen as ‘the bad guys’.”

Sharing the load

Government and the capital markets are essential participants in insuring against tomorrow’s weather. This was the overwhelming conclusion of the survey. Respondents were asked to pick those three alternative risk transfer mechanisms they believed had the most potential to aid the industry in absorbing increasing natural catastrophe losses. Twenty-seven percent opted for government-backed catastrophe pools, 25% said insurance-linked securities (such as cat bonds) had most potential and 22% went for weather derivatives. Other, less popular, options were industry-loss warranties, captives and sidecars. Looked at another way though, nearly two thirds opted for capital market solutions (see figure 1).

“Peak natural disaster zones will gradually become a bad business. Governments should promote to live in safe zones, that’s not difficult

The convergence between insurance and the capital markets is an essential aspect of viably covering tomorrow’s risks it seems. Hedge fund and private equity money was identified by respondents as important sources of finance. Whether these investors were here to stay was questionable however. “As long as there are ‘investors’ prepared to ‘take a punt’, there will be a market,” said a UK-based consultant. “However, if the incidence of loss becomes almost a foregone conclusion, this market will dry up.”

Others saw lots of untapped potential. “The capital markets ability to absorb cat risk is multiples of what it has absorbed to date,” said the president and CEO of a US-based reinsurance broker. “As long as transparency exists… then expect the trend for increased capital market involvement to continue.” Institutional money managers are the most important investor class in terms of future capacity, believes Ozizmir. He sees greater untapped potential with debt investors as opposed to private equity investors, which are a “marginal extention” of the insurance industry’s existing equity base. “Debt capacity truly expands the industry’s ability to increase availability and affordability,” he explains.

The frequent “unknowns” associated with climate change had many survey respondents concerned. “Had our shareholders wanted to invest in gambling they would have bought casino shares,” said an Asia-based reinsurance manager. Most were in agreement that ultimately government needed to be involved in this “unquantifiable risk”. “Government intervention will be required if climate change has severe effects,” said the head of catastrophe underwriting at a European reinsurance company. Many backed the idea of government backstops, particularly if peak zones become uninsurable (57% thought they could if each year saw a “Katrina-size loss” of in excess of $40bn). Seventy-seven percent said governments should act as insurers of last resort to ensure affordable coverage.

The responsibility doesn’t end there. According to the reinsurance surveillance subdirector of a Latin American regulator: “Peak natural disaster zones will gradually become a bad business. Governments should promote to live in safe zones, that’s not difficult.” This was clearly an issue many felt strongly about.

“Governments should be forced to participate as insurer of last resort if they continue to under-fund natural hazard protection measures and continue to allow development in disaster prone areas,” said the executive director of a London-based reinsurance broker. Others commented on the massive education and loss prevention role that governments could play.

Yet many do not believe that the industry has a social responsibility. Forty-seven percent said we would not see significant numbers of insurers offloading their investments in industries and companies perceived to be heavy carbon-producers. “Insurers currently invest in tobacco and drinks companies and arms manufacturers, all who produce products that are known to kill millions of people every year,” put the group insurance manager of a major UK bank rather bluntly. “Why would they decide to withdraw investment simply because a company produces carbon dioxide?”