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Helen YatesMay 05, 2020
Climate Change: The cost of inaction
Climate Change: The cost of inaction
Climate Change: The Cost of Inaction
May 05, 2020

With pressure from multiple directions for a change in the approach to climate risk, how the insurance industry responds is under scrutiny Severe threats to the climate account for all of the top long-term risks in this year’s World Economic Forum (WEF) “Global Risks Report.” For the first time in the survey’s 10-year outlook, the top five global risks in terms of likelihood are all environmental. From an industry perspective, each one of these risks has potentially significant consequences for insurance and reinsurance companies: Extreme weather events with major damage to property, infrastructure and loss of human life Failure of climate change mitigation and adaptation by governments and businesses Man-made environmental damage and disasters including massive oil spills and incidents of radioactive contamination Major biodiversity loss and ecosystem collapse (terrestrial or marine) with irreversible consequences for the environment, resulting in severely depleted resources for humans as well as industries Major natural disasters such as earthquakes, tsunamis, volcanic eruptions and geomagnetic storms “There is mounting pressure on companies from investors, regulators, customers and employees to demonstrate their resilience to rising climate volatility,” says John Drzik, chairman of Marsh and McLennan Insights. “Scientific advances mean that climate risks can now be modeled with greater accuracy and incorporated into risk management and business plans. High-profile events, like recent wildfires in Australia and California, are adding pressure on companies to take action on climate risk.” There is mounting pressure on companies from investors, regulators, customers and employees to demonstrate their resilience to rising climate volatility”  John Drzik Marsh and McLennan Insights In December 2019, the Bank of England introduced new measures for insurers, expecting them to assess, manage and report on the financial risks of climate change as part of the bank’s 2021 Biennial Exploratory Scenario (BES) exercise. The BES builds on the Prudential Regulatory Authority’s Insurance Stress Test 2019, which asked insurers to stress test their assets and liabilities based on a series of future climate scenarios. The Network for the Greening of the Financial System shows how regulators in other countries are moving in a similar direction. “The BES is a pioneering exercise, which builds on the considerable progress in addressing climate-related risks that has already been made by firms, central banks and regulators,” said outgoing Bank of England governor Mark Carney. “Climate change will affect the value of virtually every financial asset; the BES will help ensure the core of our financial system is resilient to those changes.” The insurance industry’s approach to climate change is evolving. Industry-backed groups such as ClimateWise have been set up to respond to the challenges posed by climate change while also influencing policymakers. “Given the continual growth in exposure to natural catastrophes, insurance can no longer simply rely on a strategy of assessing and re-pricing risk,” says Maurice Tulloch, former chair of ClimateWise and CEO of international insurance at Aviva. “Doing so threatens a rise of uninsurable markets.” The Cost of Extreme Events In the past, property catastrophe (re)insurers were able to recalibrate their perception of natural catastrophe risk on an annual basis, as policies came up for renewal, believing that changes to hazard frequency and/or severity would occur incrementally over time. However, it has become apparent that some natural hazards have a much greater climate footprint than had been previously imagined. Attribution studies are helping insurers and other stakeholders to measure the financial impact of climate change on a specific event. “You have had events in the last few years that have a climate change signature to them,” says Robert Muir-Wood, chief research officer of science and technology at RMS. “That could include wildfire in California or extraordinary amounts of rainfall during Hurricane Harvey over Houston, or the intensity of hurricanes in the Caribbean, such as Irma, Maria and Dorian. “These events appear to be more intense and severe than those that have occurred in the past,” he continues. “Attribution studies are corroborating the fact that these natural disasters really do have a climate change signature. It was a bit experimental to start with, but now it’s just become a regular part of the picture, that after every event a designated attribution study program will be undertaken … often by more than one climate lab. “In the past it was a rather futile argument whether or not an event had a greater impact because of climate change, because you couldn’t really prove the point,” he adds. “Now it’s possible to say not only if an event has a climate change influence, but by how much. The issue isn’t whether something was or was not climate change, it’s that climate change has affected the probability of an event like that by this amount. That is the nature of the conversation now, which is an intelligent way of thinking about it.” Now it’s possible to say not only if an event has a climate change influence, but by how much. The issue isn’t whether something was or was not climate change, it’s that climate change has affected the probability of an event like that by this amount  Robert Muir-Wood RMS Record catastrophe losses in 2017 and 2018 — with combined claims costing insurers US$230 billion, according to Swiss Re sigma — have had a significant impact on the competitive and financial position of many property catastrophe (re)insurers. The loss tally from 2019 was less severe, with global insurance losses below the 10-year average at US$56 billion, but Typhoons Faxai and Hagibis caused significant damage to Japan when they occurred just weeks apart in September and October. “It can be argued that the insurance industry is the only sector that is going to be able to absorb the losses from climate change,” adds Muir-Wood. “Companies already feel they are picking up losses in this area and it’s a bit uncharted — you can’t just use the average of history. It doesn’t really work anymore. So, we need to provide the models that give our clients the comfort of knowing how to handle and price climate change risks in anticipation.” The Cost of Short-Termism While climate change is clearly on the agenda of the boards of international insurance and reinsurance firms, its emphasis differs from company to company, according to the Geneva Association. In a report, the industry think tank found that insurers are hindered from scaling up their contribution to climate adaptation and mitigation by barriers that are imposed at a public policy and regulatory level. The need to take a long-term view on climate change is at odds with the pressures that insurance companies are under as public and regulated entities. Shareholder expectations and the political demands to keep insurance rates affordable are in conflict with the need to charge a risk-adjusted price or reduce exposures in regions that are highly catastrophe exposed. Examples of this need to protect property owners from full risk pricing became an election issue in the Florida market when state-owned carrier Florida Citizens supported customers with effectively subsidized premiums. The disproportionate emphasis on using the historical record as a means of modeling the probability of future losses is a further challenge for the private market operating in the state. “In the past when insurers were confronted with climate change, they were comfortable with the sense that they could always put up the price or avoid writing the business if the risk got too high,” says Muir-Wood. “But I don’t think that’s a credible position anymore. We see situations, such as in California, where insurers are told they should already have priced in climate change risk and they need to use the average of the last 30 years, and that’s obviously a challenge for the solvency of insurers. Regulators want to be up to speed on this. If levels of risk are increasing, they need to make sure that (re)insurance companies can remain solvent. That they have enough capital to take on those risks. “The Florida Insurance Commissioner’s function is more weighted to look after the interests of consumers around insurance prices, and they maintain a very strong line that risk models should be calibrated against the long-term historical averages,” he continues. “And they’ve said that both in Florida for hurricane and in California for wildfire. And in a time of change and a time of increased risk, that position is clearly not in the interest of insurers, and they need to be thinking carefully about that. “Regulators want to be up to speed on this,” he adds. “If levels of risk are increasing, they need to make sure that (re)insurance companies can remain solvent. That they have enough capital to take on those risks. And supervisors will expect the companies they regulate to turn up with extremely good arguments and a demonstration of the data behind their position as to how they are pricing their risk and managing their portfolios.” The Reputational Cost of Inaction Despite the persistence of near-term pressures, a lack of action and a long-term view on climate change is no longer a viable option for the industry. In part, this is due to a mounting reputational cost. European and Australian (re)insurers have, for instance, been more proactive in divesting from fossil fuels than their American and Asian counterparts. This is expected to change as negative attention mounts in both mainstream and social media. The industry’s retreat from coal is gathering pace as public pressure on the fossil fuel industry and its supporters grows. The number of insurers withdrawing cover for coal more than doubled in 2019, with coal exit policies announced by 17 (re)insurance companies. “The role of insurers is to manage society’s risks — it is their duty and in their own interest to help avoid climate breakdown,” says Peter Bosshard, coordinator of the Unfriend Coal campaign. “The industry’s retreat from coal is gathering pace as public pressure on the fossil fuel industry and its supporters grows.” The influence of climate change activists such as Greta Thunberg, the actions of NGO pressure groups like Unfriend Coal and growing climate change disclosure requirements are building a critical momentum and scrutiny into the action (or lack thereof) taken by insurance senior management. “If you are in the driver’s seat of an insurance company and you know your customers’ attitudes are shifting quite fast, then you need to avoid looking as though you are behind the curve,” says Muir-Wood. “Quite clearly there is a reputational side to this. Attitudes are changing, and as an industry we should anticipate that all sorts of things that are tolerated today will become unacceptable in the future.” To understand your organization’s potential exposure to climate change contact the RMS team here

Helen YatesMay 20, 2019
The future of risk management
The future of risk management
The Future of Risk Management
May 20, 2019

(Re)insuring new and emerging risks requires data and, ideally, a historical loss record upon which to manage an exposure. But what does the future of risk management look like when so many of these exposures are intangible or unexpected?  Sudden and dramatic breakdowns become more likely in a highly interconnected and increasingly polarized world, warns the “Global Risks Report 2019” from the World Economic Forum (WEF). “Firms should focus as much on risk response as on risk mitigation,” advises John Drzik, president of global risk and digital at Marsh, one of the report sponsors. “There’s an inevitability to having a certain number of shock events, and firms should focus on how to respond to fast-moving events with a high degree of uncertainty.” Macrotrends such as climate change, urbanization and digitization are all combining in a way that makes major claims more impactful when things go wrong. But are all low-probability/high-consequence events truly beyond our ability to identify and manage? Dr. Gordon Woo, catastrophist at RMS, believes that in an age of big data and advanced analytics, information is available that can help corporates, insurers and reinsurers to understand the plethora of new and emerging risks they face. “The sources of emerging risk insight are out there,” says Woo. “The challenge is understanding the significance of the information available and ensuring it is used to inform decision-makers.” However, it is not always possible to gain access to the insight needed. “Some of the near-miss data regarding new software and designs may be available online,” says Woo. “For example, with the Boeing 737 Max 8, there were postings by pilots where control problems were discussed prior to the Lion Air disaster of October 2018. Equally, intelligence information on terrorist plots may be available from online terrorist chatter. But typically, it is much harder for individuals to access this information, other than security agencies. “Peter Drucker [consultant and author] was right when he said: ‘If you can’t measure it, you can’t improve it,’” he adds. “And this is the issue for (re)insurers when it comes to emerging risks. There is currently not a lot of standardization between risk compliance systems and the way the information is gathered, and corporations are still very reluctant to give information away to insurers.” The Intangibles Protection Gap While traditional physical risks, such as fire and flood, are well understood, well modeled and widely insured, new and emerging risks facing businesses and communities are increasingly intangible and risk transfer solutions are less widely available. While there is an important upside to many technological innovations, for example, there are also downsides that are not yet fully understood or even recognized, thinks Robert Muir-Wood, chief research officer of science and technology at RMS. “Last year’s Typhoon Jebi caused coastal flooding in the Kansai region of Japan,” he says. “There were a lot of cars on the quayside close to where the storm made landfall and many of these just caught on fire. It burnt out a large number of cars that were heading for export. “The reason for the fires was the improved capability of batteries in cars,” he explains. “And when these batteries are immersed in water they burst into flames. So, with this technology you’ve created a whole new peril. There is currently not a lot of standardization between risk compliance systems and the way the information is gathered Gordon Woo RMS “As new technology emerges, new risks emerge,” he concludes. “And it’s not as though the old risks go away. They sort of morph and they always will. Clearly the more that software becomes a critical part of how things function, then there is more of an opportunity for things to go wrong.” From nonphysical-damage business interruption and reputational harm to the theft of intellectual property and a cyber data breach, the ability for underwriters to get a handle on these risks and potential losses is one of the industry’s biggest modern-day challenges. The dearth of products and services for esoteric commercial risks is known as the “intangibles protection gap,” explains Muir-Wood. “There is this question within the whole span of risk management of organizations — of which an increasing amount is intangible — whether they will be able to buy insurance for those elements of their risk that they feel they do not have control over.” While the (re)insurance industry is responding with new products and services geared toward emerging risks, such as cyber, there are some organizational perils, such as reputational risk, that are best addressed by instilling the right risk management culture and setting the tone from the top within organizations, thinks Wayne Ratcliffe, head of risk management at SCOR. “Enterprise risk management is about taking a holistic view of the company and having multidisciplinary teams brainstorming together,” he says. “It’s a tendency of human nature to work in silos in which everyone has their own domain to protect and to work on, but working across an organization is the only way to carry out proper risk management. “There are many causes and consequences of reputational risk, for instance,” he continues. “When I think of past examples where things have gone horribly wrong — and there are so many of them, from Deepwater Horizon to Enron — in certain cases there were questionable ethics and a failure in risk management culture. Companies have to set the tone at the top and then ensure it has spread across the whole organization. This requires constant checking and vigilance.” The best way of checking that risk management procedures are being adhered to is by being really close to the ground, thinks Ratcliffe. “We’re moving too far into a world of emails and communication by Skype. What people need to be doing is talking to each other in person and cross-checking facts. Human contact is essential to understanding the risk.” Spotting the Next “Black Swan” What of future black swans? As per Donald Rumsfeld’s “unknown unknowns,” so called black swan events are typically those that come from left field. They take everyone by surprise (although are often explained away in hindsight) and have an impact that cascades through economic, political and social systems in ways that were previously unimagined, with severe and widespread consequences. “As (re)insurers we can look at past data, but you have to be aware of the trends and forces at play,” thinks Ratcliffe. “You have to be aware of the source of the risk. In ‘The Big Short’ by Michael Lewis, the only person who really understood the impending subprime collapse was the one who went house-to-house asking people if they were having trouble paying their mortgages, which they were. New technologies are creating more opportunities but they’re also making society more vulnerable to sophisticated cyberattacks Wayne Ratcliffe SCOR “Sometimes you need to go out of the bounds of data analytics into a more intuition-based way of picking up signals where there is no data,” he continues. “You need imagination and to come up with scenarios that can happen based on a group of experts talking together and debating how exposures can connect and interconnect. “It’s a little dangerous to base everything on big data measurement and statistics, and at SCOR we talk about the ‘art and science of risk,’” he continues. “And science is more than statistics. We often need hard science behind what we are measuring. A single-point estimate of the measure is not sufficient. We also need confidence intervals corresponding to a range of probabilities.” In its “Global Risks Report 2019,” the WEF examines a series of “what-if” future shocks and asks if its scenarios, while not predictions, are at least “a reminder of the need to think creatively about risk and to expect the unexpected?” The WEF believes future shocks could come about as a result of advances in technology, the depletion of global resources and other major macrotrends clashing in new and extreme ways. “The world is becoming hyperconnected,” says Ratcliffe. “People are becoming more dependent on social media, which is even shaping political decisions, and organizations are increasingly connected via technology and the internet of things. New technologies are creating more opportunities but they’re also making society more vulnerable to sophisticated cyberattacks. We have to think about the systemic nature of it all.” As governments are pressured to manage the effects of climate change, for instance, will the use of weather manipulation tools — such as cloud seeding to induce or suppress rainfall — result in geopolitical conflict? Could biometrics and AI that recognize and respond to emotions be used to further polarize and/or control society? And will quantum computing render digital cryptography obsolete, leaving sensitive data exposed? The risk of cyberattack was the No. 1 risk identified by business leaders in virtually all advanced economies in the WEF’s “Global Risks Report 2019,” with concern about both data breach and direct attacks on company infrastructure causing business interruption. The report found that cyberattacks continue to pose a risk to critical infrastructure, noting the attack in July 2018 that compromised many U.S. power suppliers. In the attack, state-backed Russian hackers gained remote access to utility- company control rooms in order to carry out reconnaissance. However, in a more extreme scenario the attackers were in a position to trigger widespread blackouts across the U.S., according to the Department of Homeland Security. Woo points to a cyberattack that impacted Norsk Hydro, the company that was responsible for a massive bauxite spill at an aluminum plant in Brazil last year, with a targeted strain of ransomware known as “LockerGoga.” With an apparent motivation to wreak revenge for the environmental damage caused, hackers gained access to the company’s IT infrastructure, including the control systems at its aluminum smelting plants. He thinks a similar type of attack by state-sponsored actors could cause significantly greater disruption if the attackers’ motivation was simply to cause damage to industrial control systems. Woo thinks cyber risk has significant potential to cause a major global shock due to the interconnected nature of global IT systems. “WannaCry was probably the closest we’ve come to a cyber 911,” he explains. “If the malware had been released earlier, say January 2017 before the vulnerability was patched, losses would have been a magnitude higher as the malware would have spread like measles as there was no herd immunity. The release of a really dangerous cyber weapon with the right timing could be extremely powerful.”

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