Tag: climate change
At Exceedance 2020, RMS explored the key forces currently disrupting the industry, from technology, data analytics and the cloud through to rising extremes of catastrophic events like the pandemic and climate change. This coupling of technological and environmental disruption represents a true inflection point for the industry. EXPOSURE asked six experts across RMS for their views on why they believe these forces will change everything Cloud Computing: Moe Khosravy, Executive Vice President, Software and Platforms How are you seeing businesses transition their workloads over to the cloud? I have to say it’s been remarkable. We’re way past basic conversations on the value proposition of the cloud to now having deep technical discussions that are truly transformative plays. Customers are looking for solutions that seamlessly scale with their business and platforms that lower their cost of ownership while delivering capabilities that can be consumed from anywhere in the world. Why is the cloud so important or relevant now? It is now hard for a business to beat the benefits that the cloud offers and getting harder to justify buying and supporting complex in-house IT infrastructure. There is also a mindset shift going on — why is an in-house IT team responsible for running and supporting another vendor’s software on their systems if the vendor itself can provide that solution? This burden can now be lifted using the cloud, letting the business concentrate on what it does best. Has the pandemic affected views of being in the cloud? I would say absolutely. We have always emphasized the importance of cloud and true SaaS architectures to enable business continuity — allowing you to do your work from anywhere, decoupled from your IT and physical footprint. Never has the importance of this been more clearly underlined than during the past few months. Risk Analytics: Cihan Biyikoglu, Executive Vice President, Product What are the specific industry challenges that risk analytics is solving or has the potential to solve? Risk analytics really is a wide field, but in the immediate short term one of the focus areas for us is improving productivity around data. So much time is spent by businesses trying to manually process data — cleansing, completing and correcting data — and on conversion between incompatible datasets. This alone is a huge barrier just to get a single set of results. If we can take this burden away, give decision-makers the power to get results in real time with automated and efficient data handling, then with that I believe we will liberate them to use the latest insights to drive business results. Another important innovation here are the HD Models™. The power of the new engine with its improved accuracy I believe is a game changer that will give our customers a competitive edge. How will risk analytics impact activities and capabilities within the market? As seen in other industries, the more data you can combine, the better the analytics become — that’s the universal law of analytics. Getting all of this data on a unified platform and combining different datasets unearths new insights, which could produce opportunities to serve customers better and drive profit or growth. What are the longer-term implications for risk analytics? In my view, it’s about generating more effective risk insights from analytics, results in better decision- making and the ability to explore new product areas with more confidence. It will spark a wave of innovation to profitably serve customers with exciting products and understand the risk and cost drivers more clearly. How is RMS capitalizing on risk analytics? At RMS, we have the pieces in place for clients to accelerate their risk analytics with the unified, open platform, Risk Intelligence™, which is built on a Risk Data Lake™ in the cloud and is ready to take all sources of data and unearth new insights. Applications such as Risk Modeler™ and ExposureIQ™ can quickly get decision-makers to the analytics they need to influence their business. Open Standards: Dr. Paul Reed, Technical Program Manager, RDOS Why are open standards so important and relevant now? I think the challenges of risk data interoperability and supporting new lines of business have been recognized for many years, as companies have been forced to rework existing data standards to try to accommodate emerging risks and to squeeze more data into proprietary standards that can trace their origins to the 1990s. Today, however, with the availability of big data technology, cloud platforms such as RMS Risk Intelligence and standards such as the Risk Data Open Standard™ (RDOS) allow support for high-resolution risk modeling, new classes of risk, complex contract structures and simplified data exchange. Are there specific industry challenges that open standards are solving or have the potential to solve? I would say that open standards such as the RDOS are helping to solve risk data interoperability challenges, which have been hindering the industry, and provide support for new lines of business. In the case of the RDOS, it’s specifically designed for extensibility, to create a risk data exchange standard that is future-proof and can be readily modified and adapted to meet both current and future requirements. Open standards in other industries, such as Kubernetes, Hadoop and HTML, have proven to be catalysts for collaborative innovation, enabling accelerated development of new capabilities. How is RMS responding to and capitalizing on this development? RMS contributed the RDOS to the industry, and we are using it as the data framework for our platform called Risk Intelligence. The RDOS is free for anyone to use, and anyone can contribute updates that can expand the value and utility of the standard — so its development and direction is not dependent on a single vendor. We’ve put in place an independent steering committee to guide the development of the standard, currently made up of 15 companies. It provides benefits to RMS clients not only by enhancing the new RMS platform and applications, but also by enabling other industry users who create new and innovative products and address new and emerging risk classes. Pandemic Risk: Dr. Gordon Woo, Catastrophist How does pandemic risk affect the market? There’s no doubt that the current pandemic represents a globally systemic risk across many market sectors, and insurers are working out both what the impact from claims will be and the impact on capital. For very good reasons, people are categorizing the COVID-19 disease as a game-changer. However, in my view, SARS [severe acute respiratory syndrome] in 2003, MERS [Middle East respiratory syndrome] in 2012 and Ebola in 2014 should also have been game-changers. Over the last decade alone, we have seen multiple near misses. It’s likely that suppression strategies to combat the coronavirus will probably continue in some form until a vaccine is developed, and governments must strike this uneasy balance between their economies and the opening of their populations to exposure from the virus. What are the longer-term implications of this current pandemic for the industry? It’s clear that the mitigation of pandemic risk will need to be prioritized and given far more urgency than before. There’s no doubt in my mind that events such as the 2014 Ebola crisis were a missed opportunity for new initiatives in pandemic risk mitigation. Away from the life and health sector, all insurers will need to have a better grasp on future pandemics, after seeing the impact of COVID-19 and its wide business impact. The market could look to bold initiatives with governments to examine how to cover future pandemics, similar to how terror attacks are covered as a pooled risk. How is RMS helping its clients in relation to COVID-19? Since early January when the first cases emerged from Wuhan, China, we’ve been supporting our clients and the wider market in gaining a better understanding of the diverse loss implications of COVID-19. Our LifeRisks® team has been actively assisting in pandemic risk management, with regular communications and briefings, and will incorporate new perspectives from COVID-19 into our infectious diseases modeling. Climate Change: Ryan Ogaard, Senior Vice President, Model Product Management Why is climate change so relevant to the market now? There are many reasons. Insurers and their stakeholders are looking at the constant flow of catastrophes, from the U.S. hurricane season of 2017, wildfires in California and bushfires in Australia, to recent major typhoons and wondering if climate change is driving extreme weather risk, and what it could do in the future. They’re asking whether the current extent of climate change risk is priced into their premiums. Regulators are also beginning to conduct stress tests on the potential impact of climate change in the future, and insurers must respond. How will climate change impact how the market operates? Similar to any risk, insurers need to understand and quantify how the physical risk of climate change will impact their portfolios and adjust their strategy accordingly. Also, over the coming years it appears likely that regulators will incorporate climate change reporting into their regimes. Once an insurer understands their exposure to climate change risk, they can then start to take action — which will impact how the market operates. These actions could be in the form of premium changes, mitigating actions such as supporting physical defenses, diversifying the risk or taking on more capital. How is RMS responding to market needs around climate change? RMS is listening to the needs of clients to understand their pain points around climate change risk, what actions they are taking and how we can add value. We’re working with a number of clients on bespoke studies that modify the current view of risk to project into the future and/or test the sensitivity of current modeling assumptions. We’re also working to help clients understand the extent to which climate change is already built into risk models, to educate clients on emerging climate change science and to explain whether there is or isn’t a clear climate change signal for a particular peril. Cyber: Dr. Christos Mitas, Vice President, Model Development How is this change currently manifesting itself? While cyber risk itself is not new, for anyone involved in protecting or insuring organizations against cyberattacks, they will know that the nature of cyber risk is forever evolving. This could involve changes in those perpetrating the attacks, from lone wolf criminals to state-backed actors or the type of target from an unpatched personal computer to a power-plant control system. If you take the current COVID-19 pandemic, this has seen cybercriminals look to take advantage of millions of employees working from home or vulnerable business IT infrastructure. Change to the threat landscape is a constant for cyber risk. Why is cyber risk so important and relevant right now? Simply because new cyber risks emerge, and insurers who are active in this area need to ensure they are ahead of the curve in terms of awareness and have the tools and knowledge to manage new risks. There have been systemic ransomware attacks over the last few years, and criminals continue to look for potential weaknesses in networked systems, third-party software, supply chains — all requiring constant vigilance. It’s this continual threat of a systemic attack that requires insurers to use effective tools based on cutting-edge science, to capture the latest threats and identify potential risk aggregation. How is RMS responding to market needs around cyber risk? With our latest RMS Cyber Solutions, which is version 4.0, we’ve worked closely with clients and the market to really understand the pain points within their businesses, with a wealth of new data assets and modeling approaches. One area is the ability to know the potential cyber risk of the type of business you are looking to insure. In version 4.0, we have a database of over 13 million businesses that can help enrich the information you have about your portfolio and prospective clients, which then leads to more prudent and effective risk modeling. A Time to Change Our industry is undergoing a period of significant disruption on multiple fronts. From the rapidly evolving exposure landscape and the extraordinary changes brought about by the pandemic to step-change advances in technology and seismic shifts in data analytics capabilities, the market is undergoing an unparalleled transition period. As Exceedance 2020 demonstrated, this is no longer a time for business as usual. This is what defines leaders and culls the rest. This changes everything.
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
Insurance-linked securities (ILS) investors want to know more about how climate change impacts investment decisions, according to Paul Wilson, head of non-life analytics at Securis Investment Partners, an ILS asset manager We make investments that are typically annual to two-to-three years in duration, so we need to understand the implications of climate change on those timescales,” explains Paul Wilson, head of non-life analytics at Securis Investment Partners. “We reevaluate investments as part of any renewal process, and it’s right to ask if any opportunity is still attractive given what we know about how our climate is changing. “The fundamental question that we’re trying to address is, ‘Have I priced the risk of this investment correctly for the next year?’” he continues. “And therefore, we need to know if the catastrophe models we are using accurately account for the impact climate change may be having. Or are they overly reliant on historical data and, as such, are not actually representing the true current risk levels for today’s climate?” Expertise in climate change is a requirement for how Securis is thinking about risk. “We have investors who are asking questions about climate change, and we have a responsibility to be able to demonstrate to them that we are taking the implications into consideration in our investment decisions.” “We have investors who are asking questions about climate change, and we have a responsibility to demonstrate to them that we are taking the implications into consideration in our investment decisions Paul Wilson Securis Investment Partners The rate at which a changing climate may influence natural catastrophes will present both a challenge and opportunity to the wider industry as well as to catastrophe modeling companies, thinks Wilson. The results coming out of climate change attribution studies are going to have to start informing the decisions around risk. For example, according to attribution studies, climate change tripled the chances of Hurricane Harvey’s record rainfall. “Climate change is a big challenge for the catastrophe modeling community,” he says. “It’s going to put a greater burden on catastrophe modelers to ensure that their models are up to date. The frequency and nature of model updates will have to change. Models we are using today may become out of date in just a few years’ time. That’s interesting when you think about the number of perils and regions where climate change could have a significant impact. “All of those climate-related models could be impacted by climate change, so we have to question the impact that is having today,” he adds. “If the model you are using to price the risk has been calibrated to the last 50 years, but you believe the last 10 or last 20 years are more representative because of the implication of climate change, then how do you adjust your model according to that? That’s the question we should all be looking to address.”
As environmental, social and governance principles become more prominent in guiding investment strategies, the ILS market must respond In recent years, there has been a sharper focus by the investment community on responsible investment. One indicator of this has been the increased adoption of the Principles for Responsible Investment (PRI), as environmental, social and governance (ESG) concerns become a more prominent influencer of investment strategies. Investment houses are also seeking closer alignment between their ESG practices and the United Nations’ Sustainable Development Goals (SDGs). The 17 interconnected SDGs, set in 2015, are a call to action to end poverty, achieve peace and prosperity for all, and create a sustainable society by 2030. As investors target more demonstrable outcomes from their investment practices, is there a possible opportunity for the insurance-linked securities (ILS) market to grow, given the potential societal capital that insurance can generate? “Insurance certainly has all of the hallmarks of an ESG-compatible investment opportunity,” believes Charlotte Acton, director of capital and resilience solutions at RMS. “It has the potential to promote resilience through enabling broader access and uptake of appropriate affordable financial protection and reducing the protection gap; supporting faster and more efficient responses to disasters; and incentivizing mitigation and resilient building practices pre- and post-event.” RMS has been collaborating on numerous initiatives designed to further the role of insurance and insurance technologies in disaster and climate-change resilience. These include exploring ways to monetize the dividends of resilience to incentivize resilient building, using catastrophe models to quantify the benefits of resilience investments such as flood defenses, and earthquake retrofit programs for housing. The work has also involved designing innovative parametric structures to provide rapid post-disaster liquidity. “Investors will want a clear understanding of the exposure or assets that are being protected and whether they are ESG-friendly” Charlotte Acton RMS “ILS offers a clear route for investors to engage with insurance,” explains Acton, “broadening the capital pool that supports insurance is critical as it facilitates the expansion of insurance to new regions and allows the industry to absorb increasingly large losses from growing threats such as climate change.” Viewed as a force for social good, it can certainly be argued that insurance-linked securities supports a number of the U.N.’s SDGs, including reducing the human impact of disasters and creating more sustainable cities, increasing overall resilience levels and increasing access to financial services that enhance sustainable growth potential. While there is opportunity for ILS to play a large part in ESG, the specific role of ILS within PRI is still being determined. According to LGT Capital Partners ESG Report 2019, managers in the ILS space have, in general, yet to start “actively integrating ESG into their investment strategies,” adding that across the ILS asset class “there is still little agreement on how ESG considerations should be applied. However, there is movement in this area. For example, the Bermuda Stock Exchange, a primary exchange for ILS issuers, recently launched an ESG initiative in line with the World Federation of Exchanges’ Sustainability Principles, stating that ESG was a priority in 2019 “with the aim to empower sustainable and responsible growth for its member companies, listings and the wider community.” For ILS to become a key investment option for ESG-focused investors, it must be able to demonstrate its sustainability credentials clearly. “Investors will want a clear understanding of the exposure or assets that are being protected,” Acton explains, “and whether they are ESG-friendly. They will want to know whether the protection offered provides significant societal benefits. If the ILS market can factor ESG considerations into its approach more effectively, then there is no reason why it should not attract greater attention from responsible investors.”
Why the PRA’s stress test has pushed climate change to the top of (re)insurance company agendas As part of its 2019 biennial insurance stress test, the U.K. insurance industry regulator — for the first time — asked insurers and reinsurers to conduct an exploratory exercise in relation to climate change. Using predictions published by the United Nations’ Intergovernmental Panel on Climate Change (IPCC) and in other academic literature, the Bank of England’s Prudential Regulation Authority (PRA) came up with a series of future climate change scenarios, which it asked (re)insurers to use as a basis for stress-testing the impact on their assets and liabilities. The PRA stress test came at a time when pressure is building for commercial and financial services businesses around the world to assess the likely impact of climate change on their business, through initiatives such as the Task Force for Climate-Related Financial Disclosures (TCFD). The submission deadline for the stress-tested scenarios ended on October 31, 2019, following which the PRA will publish a summary of overall results. From a property catastrophe (re)insurance industry perspective, the importance of assessing the potential impact, both in the near and long term, is clear. Companies must ensure their underwriting strategies and solvency levels are adequate so as to be able to account for additional losses from rising sea levels, more climate extremes, and potentially more frequent and/or intense natural catastrophes. Then there’s the more strategic considerations in the long term — how much coverages change and what will consumers demand in a changing climate? The PRA stress test, explains Callum Higgins, product manager of global climate at RMS, is the regulator’s attempt to test the waters. The hypothetical narratives are designed to help companies think about how different plausible futures could impact their business models, according to the PRA. “The climate change scenarios are not designed to assess current financial resilience but rather to provide additional impetus in this area, with results comparable across firms to better understand the different approaches companies are using.” “There was pressure on clients to respond to this because those that don’t participate will probably come under greater scrutiny” Callum Higgins RMS RMS was particularly well placed to support (re)insurers in responding to the “Assumptions to Assess the Impact on an Insurer’s Liabilities” section of the climate change scenarios, with catastrophe models the perfect tools to evaluate such physical climate change risk to liabilities. This portion of the stress test examined how changes in both U.S. hurricane and U.K. weather risk under the different climate change scenarios may affect losses. The assumptions around U.K. weather included shifts in U.K. inland and coastal flood hazard, looking at the potential loss changes from increased surface runoff and sea level rise. While in the U.S., the assumptions included a 10 percent and 20 percent increase in the frequency of major hurricanes by 2050 and 2100, respectively. “While the assumptions and scenarios are hypothetical, it is important (re)insurers use this work to develop their capabilities to understand physical climate change risk,” says Higgins. “At the moment, it is exploratory work, but results will be used to guide future exercises that may put (re)insurers under pressure to provide more sophisticated responses.” Given the short timescales involved, RMS promptly modified the necessary models in time for clients to benefit for their submissions. “To help clients start thinking about how to respond to the PRA request, we provided them with industrywide factors, which allowed for the approximation of losses under the PRA assumptions but will likely not accurately reflect the impact on their portfolios. For this reason, we could also run (re)insurers’ own exposures through the adjusted models, via RMS Analytical Services, better satisfying the PRA’s requirements for those who choose this approach. “To reasonably represent these assumptions and scenarios, we think it does need help from vendor companies like RMS to adjust the model data appropriately, which is possibly out of scope for many businesses,” he adds. Detailed results based on the outcome of the stress-test exercise can be applied to use cases beyond the regulatory submission for the PRA. These or other similar scenarios can be used to sensitivity test possible answers to questions such as how will technical pricing of U.K. flood be affected by climate change, how should U.S. underwriting strategy shift in response to sea level rise or how will capital adequacy requirements change as a result of climate change — and inform strategic decisions accordingly.
(Re)insurance companies are waking up to the reality that we are in a riskier world and the prospect of ‘constant catastrophes’ has arrived, with climate change a significant driver In his hotly anticipated annual letter to shareholders in February 2019, Warren Buffett, the CEO of Berkshire Hathaway and acclaimed “Oracle of Omaha,” warned about the prospect of “The Big One” — a major hurricane, earthquake or cyberattack that he predicted would “dwarf Hurricanes Katrina and Michael.” He warned that “when such a mega-catastrophe strikes, we will get our share of the losses and they will be big — very big.” The use of new technology, data and analytics will help us prepare for unpredicted ‘black swan’ events and minimize the catastrophic losses Mohsen Rahnama RMS The question insurance and reinsurance companies need to ask themselves is whether they are prepared for the potential of an intense U.S. landfalling hurricane, a Tōhoku-size earthquake event and a major cyber incident if these types of combined losses hit their portfolio each and every year, says Mohsen Rahnama, chief risk modeling officer at RMS. “We are living in a world of constant catastrophes,” he says. “The risk is changing, and carriers need to make an educated decision about managing the risk. “So how are (re)insurers going to respond to that? The broader perspective should be on managing and diversifying the risk in order to balance your portfolio and survive major claims each year,” he continues. “Technology, data and models can help balance a complex global portfolio across all perils while also finding the areas of opportunity.” A Barrage of Weather Extremes How often, for instance, should insurers and reinsurers expect an extreme weather loss year like 2017 or 2018? The combined insurance losses from natural disasters in 2017 and 2018 according to Swiss Re sigma were US$219 billion, which is the highest-ever total over a two-year period. Hurricanes Harvey, Irma and Maria delivered the costliest hurricane loss for one hurricane season in 2017. Contributing to the total annual insurance loss in 2018 was a combination of natural hazard extremes, including Hurricanes Michael and Florence, Typhoons Jebi, Trami and Mangkhut, as well as heatwaves, droughts, wildfires, floods and convective storms. While it is no surprise that weather extremes like hurricanes and floods occur every year, (re)insurers must remain diligent about how such risks are changing with respect to their unique portfolios. Looking at the trend in U.S. insured losses from 1980–2018, the data clearly shows losses are increasing every year, with climate-related losses being the primary drivers of loss, especially in the last four decades (even allowing for the fact that the completeness of the loss data over the years has improved). Measuring Climate Change With many non-life insurers and reinsurers feeling bombarded by the aggregate losses hitting their portfolios each year, insurance and reinsurance companies have started looking more closely at the impact that climate change is having on their books of business, as the costs associated with weather-related disasters increase. The ability to quantify the impact of climate change risk has improved considerably, both at a macro level and through attribution research, which considers the impact of climate change on the likelihood of individual events. The application of this research will help (re)insurers reserve appropriately and gain more insight as they build diversified books of business. Take Hurricane Harvey as an example. Two independent attribution studies agree that the anthropogenic warming of Earth’s atmosphere made a substantial difference to the storm’s record-breaking rainfall, which inundated Houston, Texas, in August 2017, leading to unprecedented flooding. In a warmer climate, such storms may hold more water volume and move more slowly, both of which lead to heavier rainfall accumulations over land. Attribution studies can also be used to predict the impact of climate change on the return-period of such an event, explains Pete Dailey, vice president of model development at RMS. “You can look at a catastrophic event, like Hurricane Harvey, and estimate its likelihood of recurring from either a hazard or loss point of view. For example, we might estimate that an event like Harvey would recur on average say once every 250 years, but in today’s climate, given the influence of climate change on tropical precipitation and slower moving storms, its likelihood has increased to say a 1-in-100-year event,” he explains. We can observe an incremental rise in sea level annually — it’s something that is happening right in front of our eyes Pete Dailey RMS “This would mean the annual probability of a storm like Harvey recurring has increased more than twofold from 0.4 percent to 1 percent, which to an insurer can have a dramatic effect on their risk management strategy.” Climate change studies can help carriers understand its impact on the frequency and severity of various perils and throw light on correlations between perils and/or regions, explains Dailey. “For a global (re)insurance company with a book of business spanning diverse perils and regions, they want to get a handle on the overall effect of climate change, but they must also pay close attention to the potential impact on correlated events. “For instance, consider the well-known correlation between the hurricane season in the North Atlantic and North Pacific,” he continues. “Active Atlantic seasons are associated with quieter Pacific seasons and vice versa. So, as climate change affects an individual peril, is it also having an impact on activity levels for another peril? Maybe in the same direction or in the opposite direction?” Understanding these “teleconnections” is just as important to an insurer as the more direct relationship of climate to hurricane activity in general, thinks Dailey. “Even though it’s hard to attribute the impact of climate change to a particular location, if we look at the impact on a large book of business, that’s actually easier to do in a scientifically credible way,” he adds. “We can quantify that and put uncertainty around that quantification, thus allowing our clients to develop a robust and objective view of those factors as a part of a holistic risk management approach.” Of course, the influence of climate change is easier to understand and measure for some perils than others. “For example, we can observe an incremental rise in sea level annually — it’s something that is happening right in front of our eyes,” says Dailey. “So, sea-level rise is very tangible in that we can observe the change year over year. And we can also quantify how the rise of sea levels is accelerating over time and then combine that with our hurricane model, measuring the impact of sea-level rise on the risk of coastal storm surge, for instance.” Each peril has a unique risk signature with respect to climate change, explains Dailey. “When it comes to a peril like severe convective storms — tornadoes and hail storms for instance — they are so localized that it’s difficult to attribute climate change to the future likelihood of such an event. But for wildfire risk, there’s high correlation with climate change because the fuel for wildfires is dry vegetation, which in turn is highly influenced by the precipitation cycle.” Satellite data from 1993 through to the present shows there is an upward trend in the rate of sea-level rise, for instance, with the current rate of change averaging about 3.2 millimeters per year. Sea-level rise, combined with increasing exposures at risk near the coastline, means that storm surge losses are likely to increase as sea levels rise more quickly. “In 2010, we estimated the amount of exposure within 1 meter above the sea level, which was US$1 trillion, including power plants, ports, airports and so forth,” says Rahnama. “Ten years later, the exact same exposure was US$2 trillion. This dramatic exposure change reflects the fact that every centimeter of sea-level rise is subjected to a US$2 billion loss due to coastal flooding and storm surge as a result of even small hurricanes. “And it’s not only the climate that is changing,” he adds. “It’s the fact that so much building is taking place along the high-risk coastline. As a result of that, we have created a built-up environment that is actually exposed to much of the risk.” Rahnama highlighted that because of an increase in the frequency and severity of events, it is essential to implement prevention measures by promoting mitigation credits to minimize the risk. He says: “How can the market respond to the significant losses year after year. It is essential to think holistically to manage and transfer the risk to the insurance chain from primary to reinsurance, capital market, ILS, etc.,” he continues. “The art of risk management, lessons learned from past events and use of new technology, data and analytics will help to prepare for responding to unpredicted ‘black swan’ type of events and being able to survive and minimize the catastrophic losses.” Strategically, risk carriers need to understand the influence of climate change whether they are global reinsurers or local primary insurers, particularly as they seek to grow their business and plan for the future. Mergers and acquisitions and/or organic growth into new regions and perils will require an understanding of the risks they are taking on and how these perils might evolve in the future. There is potential for catastrophe models to be used on both sides of the balance sheet as the influence of climate change grows. Dailey points out that many insurance and reinsurance companies invest heavily in real estate assets. “You still need to account for the risk of climate change on the portfolio, whether you’re insuring properties or whether you actually own them, there’s no real difference.” In fact, asset managers are more inclined to a longer-term view of risk when real estate is part of a long-term investment strategy. Here, climate change is becoming a critical part of that strategy. “What we have found is that often the team that handles asset management within a (re)insurance company is an entirely different team to the one that handles catastrophe modeling,” he continues. “But the same modeling tools that we develop at RMS can be applied to both of these problems of managing risk at the enterprise level. “In some cases, a primary insurer may have a one-to-three-year plan, while a major reinsurer may have a five-to-10-year view because they’re looking at a longer risk horizon,” he adds. “Every time I go to speak to a client — whether it be about our U.S. Inland Flood HD Model or our North America Hurricane Models — the question of climate change inevitably comes up. So, it’s become apparent this is no longer an academic question, it’s actually playing into critical business decisions on a daily basis.” Preparing for a Low-carbon Economy Regulation also has an important role in pushing both (re)insurers and large corporates to map and report on the likely impact of climate change on their business, as well as explain what steps they have taken to become more resilient. In the U.K., the Prudential Regulation Authority (PRA) and Bank of England have set out their expectations regarding firms’ approaches to managing the financial risks from climate change. Meanwhile, a survey carried out by the PRA found that 70 percent of U.K. banks recognize the risk climate change poses to their business. Among their concerns are the immediate physical risks to their business models — such as the exposure to mortgages on properties at risk of flood and exposure to countries likely to be impacted by increasing weather extremes. Many have also started to assess how the transition to a low-carbon economy will impact their business models and, in many cases, their investment and growth strategy. “Financial policymakers will not drive the transition to a low-carbon economy, but we will expect our regulated firms to anticipate and manage the risks associated with that transition,” said Bank of England Governor Mark Carney, in a statement. The transition to a low-carbon economy is a reality that (re)insurance industry players will need to prepare for, with the impact already being felt in some markets. In Australia, for instance, there is pressure on financial institutions to withdraw their support from major coal projects. In the aftermath of the Townsville floods in February 2019 and widespread drought across Queensland, there have been renewed calls to boycott plans for Australia’s largest thermal coal mine. To date, 10 of the world’s largest (re)insurers have stated they will not provide property or construction cover for the US$15.5 billion Carmichael mine and rail project. And in its “Mining Risk Review 2018,” broker Willis Towers Watson warned that finding insurance for coal “is likely to become increasingly challenging — especially if North American insurers begin to follow the European lead.”
How is climate change influencing natural perils and weather extremes, and what should reinsurance companies do to respond? Reinsurance companies may feel they are relatively insulated from the immediate effects of climate change on their business, given that most property catastrophe policies are renewed on an annual basis. However, with signs that we are already moving off the historical baseline when it comes to natural perils, there is evidence to suggest that underwriters should already be selectively factoring the influence of climate change into their day-to-day decision-making. Most climate scientists agree that some of the extreme weather anticipated by the United Nations Intergovernmental Panel on Climate Change (IPCC) in 2013 is already here and can be linked to climate change in real time via the burgeoning field of extreme weather attribution. “It’s a new area of science that has grown up in the last 10 to 15 years,” explains Dr. Robert Muir-Wood, chief research officer at RMS. “Scientists run two climate models for the whole globe, both of them starting in 1950. One keeps the atmospheric chemistry static since then, while the other reflects the actual increase in greenhouse gases. By simulating thousands of years of these alternative worlds, we can find the difference in the probability of a particular weather extreme.” “Underwriters should be factoring the influence of climate change into their day-to-day decision-making” For instance, climate scientists have run their models in an effort to determine how much the intensity of the precipitation that caused such devastating flooding during last year’s Hurricane Harvey can be attributed to anthropogenic climate change. Research conducted by scientists at the World Weather Attribution (WWA) project has found that the record rainfall produced by Harvey was at least three times more likely to be due to the influence of global warming. This suggests, for certain perils and geographies, reinsurers need to be considering the implications of an increased potential for certain climate extremes in their underwriting. “If we can’t rely on the long-term baseline, how and where do we modify our perspective?” asks Muir-Wood. “We need to attempt to answer this question peril by peril, region by region and by return period. You cannot generalize and say that all perils are getting worse everywhere, because they’re not. In some countries and perils there is evidence that the changes are already material, and then in many other areas the jury is out and it’s not clear.” Keeping Pace With the Change While the last IPCC Assessment Report (AR5) was published in 2014 (the next is due in 2021), there is some consensus on how climate change is beginning to influence natural perils and climate extremes. Many regional climates naturally have large variations at interannual and even interdecadal timescales, which makes observation of climate change, and validation of predictions, more difficult. “There is always going to be uncertainty when it comes to climate change,” emphasizes Swenja Surminski, head of adaptation research at the Grantham Research Institute on Climate Change and the Environment, part of the London School of Economics and Political Science (LSE). “But when you look at the scientific evidence, it’s very clear what’s happening to temperature, how the average temperature is increasing, and the impact that this can have on fundamental things, including extreme events.” According to the World Economic Forum’s Global Risks Report in 2018, “Too little has been done to mitigate climate change and … our own analysis shows that the likelihood of missing the Paris Agreement target of limiting global warming to two degrees Celsius or below is greater than the likelihood of achieving it.” The report cites extreme weather events and natural disasters as the top two “most likely” risks to happen in the next 10 years and the second- and third-highest risks (in the same order) to have the “biggest impact” over the next decade, after weapons of mass destruction. The failure of climate change mitigation and adaptation is also ranked in the top five for both likelihood and impact. It notes that 2017 was among the three hottest years on record and the hottest ever without an El Niño. It is clear that climate change is already exacerbating climate extremes, says Surminski, causing dry regions to become drier and hot regions to become hotter. “By now, based on our scientific understanding and also thanks to modeling, we get a much better picture of what our current exposure is and how that might be changing over the next 10, 20, even 50 to 100 years,” she says. “There is also an expectation we will have more freak events, when suddenly the weather produces really unexpected, very unusual phenomena,” she continues. “That’s not just climate change. It’s also tied into El Niño and other weather phenomena occurring, so it’s a complex mix. But right now, we’re in a much better position to understand what’s going on and to appreciate that climate change is having an impact.” Pricing for Climate Change For insurance and reinsurance underwriters, the challenge is to understand the extent to which we have already deviated from the historical record and to manage and price for that appropriately. It is not an easy task given the inherent variability in existing weather patterns, according to Andy Bord, CEO of Flood Re, the U.K.’s flood risk pool, which has a panel of international reinsurers. “The existing models are calibrated against data that already includes at least some of the impact of climate change,” he says. “Some model vendors have also recently produced models that aim to assess the impact of climate change on the future level of flood risk in the U.K. We know at least one larger reinsurer has undertaken their own climate change impact analyses. “We view improving the understanding of the potential variability of weather given today’s climate as being the immediate challenge for the insurance industry, given the relatively short-term view of markets,” he adds. The need for underwriters to appreciate the extent to which we may have already moved off the historical baseline is compounded by the conflicting evidence on how climate change is influencing different perils. And by the counterinfluence or confluence, in many cases, of naturally occurring climate patterns, such as El Niño and the Atlantic Multidecadal Oscillation (AMO). The past two decades have seen below-normal European windstorm activity, for instance, and evidence builds that the unprecedented reduction in Arctic sea ice during the autumn months is the main cause, according to Dr. Stephen Cusack, director of model development at RMS. “In turn, the sea ice declines have been driven both by the ‘polar amplification’ aspect of anthropogenic climate change and the positive phase of the AMO over the past two decades, though their relative roles are uncertain. “We view improving the understanding of the potential variability of weather given today’s climate as being the immediate challenge for the insurance industry, given the relatively short-term view of markets” Andy Bord Flood Re “The (re)insurance market right now is saying, ‘Your model has higher losses than our recent experience.’ And what we are saying is that the recent lull is not well understood, and we are unsure how long it will last. Though for pricing future risk, the question is when, and not if, the rebound in European windstorm activity happens. Regarding anthropogenic climate change, other mechanisms will strengthen and counter the currently dominant ‘polar amplification’ process. Also, the AMO goes into positive and negative phases,” he continues. “It’s been positive for the last 20 to 25 years and that’s likely to change within the next decade or so.” And while European windstorm activity has been somewhat muted by the AMO, the same cannot be said for North Atlantic hurricane activity. Hurricanes Harvey, Irma and Maria (HIM) caused an estimated US$92 billion in insured losses, making 2017 the second costliest North Atlantic hurricane season, according to Swiss Re Sigma. “The North Atlantic seems to remain in an active phase of hurricane activity, irrespective of climate change influences that may come on top of it,” the study states. While individual storms are never caused by one factor alone, stressed the Sigma study, “Some of the characteristics observed in HIM are those predicted to occur more frequently in a warmer world.” In particular, it notes the high level of rainfall over Houston and hurricane intensification. While storm surge was only a marginal contributor to the losses from Hurricane Harvey, Swiss Re anticipates the probability of extreme storm surge damage in the northeastern U.S. due to higher seas will almost double in the next 40 years. “From a hurricane perspective, we can talk about the frequency of hurricanes in a given year related to the long-term average, but what’s important from the climate change point of view is that the frequency and the intensity on both sides of the distribution are increasing,” says Dr. Pete Dailey, vice president at RMS. “This means there’s more likelihood of quiet years and more likelihood of very active years, so you’re moving away from the mean, which is another way of thinking about moving away from the baseline. “So, we need to make sure that we are modeling the tail of the distribution really well, and that we’re capturing the really wet years — the years where there’s a higher frequency of torrential rain in association with events that we model.” The Edge of Insurability Over the long term, the industry likely will be increasingly insuring the impact of anthropogenic climate change. One question is whether we will see “no-go” areas in the future, where the risk is simply too high for insurance and reinsurance companies to take on. As Robert Muir-Wood of RMS explains, there is often a tension between the need for (re)insurers to charge an accurate price for the risk and the political pressure to ensure cover remains available and affordable. He cites the community at Queen’s Cove in Grand Bahama, where homes were unable to secure insurance given the repeated storm surge flood losses they have sustained over the years from a number of hurricanes. Unable to maintain a mortgage without insurance, properties were left to fall into disrepair. “Natural selection came up with a solution,” says Muir-Wood, whereby some homeowners elevated buildings on concrete stilts thereby making them once again insurable. “In high-income, flood-prone countries, such as Holland, there has been sustained investment in excellent flood defenses,” he says. “The challenge in developing countries is there may not be the money or the political will to build adequate flood walls. In a coastal city like Jakarta, Indonesia, where the land is sinking as a result of pumping out the groundwater, it’s a huge challenge. “It’s not black and white as to when it becomes untenable to live somewhere. People will find a way of responding to increased incidence of flooding. They may simply move their life up a level, as already happens in Venice, but insurability will be a key factor and accommodating the changes in flood hazard is going to be a shared challenge in coastal areas everywhere.” Political pressure to maintain affordable catastrophe insurance was a major driver of the U.S. residual market, with state-backed Fair Access to Insurance Requirements (FAIR) plans providing basic property insurance for homes that are highly exposed to natural catastrophes. Examples include the California Earthquake Association, Texas Windstorm Insurance Association and Florida Citizens Property Insurance Corporation (and state reinsurer, the FHCF). However, the financial woes experienced by FEMA’s National Flood Insurance Program (NFIP), currently the principal provider of residential flood insurance in the U.S., demonstrates the difficulties such programs face in terms of being sustainable over the long term. With the U.K.’s Flood Re scheme, investment in disaster mitigation is a big part of the solution, explains CEO Andy Bord. However, even then he acknowledges that “for some homes at the very greatest risk of flooding, the necessary investment needed to reduce risks and costs would simply be uneconomic.”