Monthly Archives: December 2015

Insurers Need a “Dual Horizon” View of Risk To Manage Climate Change

Last week, as a participant on the Joint OECD/Geneva Association Roundtable on Climate Change and the Insurance Sector, I had the opportunity to outline the (re)insurance industry’s critical role in the financial management of climate catastrophe events.

Source: COP21 Make It Work/Sciences Po

The meeting, held in Paris during The 21st Conference of the Parties (COP21) to the United Nations Framework Convention on Climate Change, gave rise to a thought-provoking discussion of the many ways in which the insurance industry will need to engage with the challenges of climate change and in particular extend its “risk horizon.”

A next generation perspective of risk

For centuries we have considered that sea level or climate stays the same. But now we must prepare for a world of constant change. A good way to start is by developing dual horizons—today and a generation away—for how we think about risk.

Today the focus of the insurance industry is short-term. Most contracts are for a single year, securitizations might run for three years, but no-one is looking beyond five years–what at RMS we call the “Medium Term.”

But as our world continues to warm and the catastrophe risk landscape evolves, we need a “next generation perspective” of risk: an additional forward-looking perspective focused 15 -35 years in the future.

Today’s (re)insurers should expect to develop plans for how they would function in a world where there is an explicit cost of carbon and more intense catastrophes from droughts to floods. Everything we build today, from city center high rises to coastal infrastructure, will still exist but in a more extreme catastrophe event environment. Already the U.K. and French insurance regulators are starting to ask questions of their supervised firms as to how their businesses would function in such a future.

In this next-generation perspective insurers will have to play an increased societal role.  Today, property owners assume that insurance will always be available. In our future world, that may become an unreasonable expectation. When determining where, and at what elevation, people can build in the flood plain, we should consider the risk over the whole future lifetime of the property, not simply the risk when the property is built.

This will require us to develop two defined datums: one for the current location of the 100-year flood zone, and a second “Next Generation” datum, showing where the 100 year flood hazard is expected to be 30+ years in the future. As highlighted by the December 2015 floods in Carlisle, northern England, flood protection already needs to consider how climate change is shifting the probabilities. When a building is constructed above the Next Generation flood datum a lifetime’s insurability may be guaranteed. These dual horizon datums will need to be objectively and independently defined, and insurers will want to be involved in determining what gets built and where.

The role of the catastrophe modelers

Since 2006, RMS has acknowledged it is no longer safe to assume that the activity of any catastrophe peril is best defined as the average of the past fifty or hundred years of history.  What then becomes the basis for determining activities and severities? We have committed more than ten person years of research to exploring what gives us the best perspective on current activity, with a focus on Atlantic hurricane. However we will need to apply the same thinking to all the climate perils.

All states of the climate contain a wide spectrum of extremes. If the climate changes, we can expect the spectrum of extremes to change. In a climate hazard catastrophe model we want to know what is the best representation of that activity, including what is the uncertainty in that estimation.

Our value to our clients comes from our true independence. This value also extends beyond the insurance industry, to providing a neutral perspective on risk to rating agencies and governments. RMS models are used by both insurers and reinsurers. They are employed for issuing securitizations and for portfolio management by investors in cat bonds. In every risk transaction, the party taking the risk will be more pessimistic than the party giving up the risk. We have a key role to play in providing a neutral science-based perspective.

Why We’re Getting Better at Changing the World

Photo by Blue Origin

Let’s start by celebrating goal achievement.  Last week, Jeff Bezos’ Blue Origin rocket successfully took off—and then returned back to Earth.  Mission accomplished. But, from 100 kilometers above the Earth’s surface, looking back at our planet, what’s the state of our global goal achievement?  Do we even have goals?

I ask this as over 50,000 delegates descend on Paris this week for the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change. Or more simply, COP21.

COP21 offers the unique prospect of 196 countries achieving a (sort of) legally binding agreement on climate change: to keep global warming below 2°C by reducing greenhouse gases. But what would a “good goal” for COP21 look like and would it ever be achieved?

Set your goal. Measure it. Achieve it.

It’s easy to get cynical about achieving BHAGs (Big Hairy Audacious Goals), but maybe a template for success has emerged. In 2000, the United Nations agreed to eight BHAGs through its global Millennium Development Goals. Goal number four was to reduce child mortality by two-thirds within 15 years across 138 developing countries.

A 50% reduction in child mortality in 15 years

In 2010, Hans Rosling’s celebrated TED talk outlined a two million annual reduction in child deaths under the age of five within a decade, down to 8.1 million per year. By the end of 2015, we will be below six million deaths per year, almost halving in 15 years.  That’s still too high, and many countries will miss the two-thirds reduction target, but nonetheless it is a huge improvement.

Source: IHME

As Rosling points out, the Millennium Goals were strong due to measurable targets. Clear targets, at individual country level, have driven the ability to lobby for increases in financial resources for clean water, immunization and antibiotics, motivated by strong partnerships and innovations in service delivery.

A goal for climate change

Rio in 1992 is remembered for establishing climate change as being caused by humans, and more specifically, primarily the responsibility of the industrialized countries.

Source: Wikipedia/EU Edgar Database

France, as host, wants to build on the momentum of Rio, but also learn lessons from past summit failures.  So, much of the COP21 framework has been defined and negotiated in advance. Francois Hollande has already agreed with top-polluter China on a mechanism to monitor cuts every five years.

The squabbling that characterized Copenhagen in 1999 will be minimized, and high expectations set for those attending, such as encouraging heads of state to arrive at the start, rather than jetting in at the end.

Frequent communication with every country participating has been critical. As conference chair, Laurent Fabius, French Foreign Minister told the FT last week “Negotiators sometimes hold firm positions that only ministers can unlock, I know their bosses – I see them all the time. We talk often, it helps”.

Infographic: Who has pledged an INDC so far, and what percentage of the world’s emissions are covered. Credit: Rosamund Pearce, Carbon Brief, based on EU data

Paris will pull out all the stops to get an agreement, but will we be willing to accept the short-term costs and constraints to slow down climate change?  The answer is probably yes.

So what are the lessons for COP21?

As Jeff Bezos’ Blue Origin extreme rocket recycling shows, individual changes in our daily behavior such as recycling and energy conservation can affect climate change, but ultimately, changes need to be government led, especially around energy generation and emission control. Whether world leaders are ready to be held legally accountable for missing their climate goals is an ongoing issue.

Nonetheless, as the Millennium Goals show, clear and well-defined targets, annually measured (“are we there yet?”) create momentum to drive change forward. The success of COP21 will be defined by whether emerging sub-goals are specific, measurable, achievable, realistic, and time bounded. Now that would be smart.