The insurance sector is being called to the front line to assess the most sustainable way forward to keep assets insurable and balance sheets healthy in the face of climate change.
The last four years have been the hottest on record, according to the World Meteorological Organization. Large parts of Europe witnessed exceptional heat and drought through the late spring and summer of 2018. In Australia, New South Wales and southern Queensland suffered significant drought with much of the region receiving less than half of its average rainfall for the period from January to September 2018. Severe drought affected Uruguay, and northern and central Argentina in late 2017 and early 2018, leading to heavy agricultural losses.
Both Japan and South Korea saw new national heat records of 41.1°C and 41.0°C, respectively. In the MENA region, Oman reported one of the highest known minimum overnight temperatures of 42.6°C in June, while Algeria saw a new national record temperature of 51.3°C in July.
In the past 40 years, Turkey has seen a reduction in rainfall (in spring) of between 20% and 50%, Jordan has an average reduction of 50%, while Egypt has an average reduction of between 60% and 90% (Maps 1 and 2).
The rising temperatures and reduction in rainfall are stark signals of climate change, which is the biggest threat to the planet, according to the World Economic Forum in its 2019 Global Risks Report. This annual analysis of economic dangers worldwide, in partnership with Marsh & McLennan Companies and Zurich Insurance Group, cited extreme weather, natural disasters, man-made environmental disasters, biodiversity loss and failure to adapt to climate change as the top perils to society. But of all the risks the world is facing, “it is in relation to the environment that the world is most clearly sleepwalking into catastrophe”, said the report, adding that “the results of climate inaction are becoming increasingly clear”.
The Intergovernmental Panel on Climate Change (IPCC) said in October 2018 that the world has at most 12 years to make the drastic and unprecedented changes needed to prevent average global temperatures from rising beyond the Paris Agreement’s 1.5°C target.
Climate change upping the ante
The insurance sector has long been on the front line when it comes to managing natural catastrophe risk. But climate change is upping the ante.
“Insurance companies are exposed to extreme weather and the impact of climate change in a variety of ways, most obviously via direct claims from traditional insurance covers related to volatile weather conditions,” said Mr Jack Jenner, CEO, MENA, Allianz Global Corporate & Specialty (AGCS). “Whether it is paying to replace roofs torn off by high winds, repairing flood damage or compensating farmers for the impact of drought, insurers have to pay out when the weather is unexpectedly bad.”
Mr Michael Gloor, Nat CAT specialist, Swiss Re said, “While the physics of global warming due to greenhouse gases are well understood, the subsequent impact on extreme weather events such as tropical cyclones or flash floods is more complex. However, we have observed an increase in extreme rainfall and floods in many regions, and such events are expected to worsen in the future. There is still considerable uncertainty around the magnitude of regional extreme-weather changes, and this is one of the key challenges for the insurance industry because it adds a further layer of uncertainty into our risk analysis. Experience and classical modelling techniques based on historic data might not be sufficient anymore to assess today’s risk landscape.”
He added, “The additional uncertainty will require the industry to monitor – more actively than now – extreme weather occurrence and its impact on claims burden. In view of the ongoing dynamic change, there is a considerable risk for the industry to significantly lag behind the true frequency and severity of natural perils. Furthermore, physical climate risks can lead to challenging macro-economic impacts that affect our industry either due to economic shocks after extreme weather events or long-term changes that affect the economic environment of a region; water scarcity and the effect on agriculture and political tensions is only one of many examples.”
Mr Jenner said, “The consequences of climate change are diverse and heterogeneous by geography, and are on the rise. The impact assessment of climate change on natural catastrophe events is an active area of research and requires detailed differentiation by peril and geographic region. Both insureds and insurers need to stay on top of changing exposures around the world to effectively manage natural catastrophe risk.”
Protecting the balance sheet
Global insured losses from catastrophes amounted to $79bn in 2018, the fourth highest on Swiss Re’s sigma records. Natural catastrophes accounted for $71bn of the insured losses, while man-made disasters accounted for the remaining $8bn. Globally, insured losses due to weather-related events have approximately doubled over the last 20 years.
With the sector shouldering much of the financial burden of the consequences of climate change, what are re(insurers) doing to protect their balance sheets?
“On the liability side of the balance sheet, traditional insurance risk assessment principles work for climate risk,” said Mr Gloor. “However, we have to accelerate the continuous review of embedded risk, but also changes to built-up environment, for example, where urbanisation is occurring at breakneck speed in many corners of Asia. This is changing the risk landscape even more dramatically than the currently observed climate change factors.”
Relating to frequent, extreme weather, rather than severe and rare catastrophes, the industry will have to closely monitor earnings volatility, he said. “Small- and medium-sized weather-related events will hit ever denser populated areas, leading to earnings rather than solvency pressure for many insurance firms if costing and pricing are not actively adjusted to changes. This is eventually a timing risk.”
The total urban population at risk from sea-level rise could number 800m people in 570 coastal cities – from Bangkok and Shanghai to New York and Miami – by 2050, according to C40 Cities, a network of 90 cities focused on battling climate change. A study by the UK National Oceanographic Centre projects the global cost of rising sea levels at $14tn per year in 2100. It found that China would face the biggest costs in absolute terms, while as a percentage of GDP, the impacts will be highest for Kuwait (24%), Bahrain (11%), the UAE (9%) and Vietnam (7%). The World Bank has identified 24 port cities in the Middle East and 19 in North Africa at particular risk of sea-level rise.
Alternative risk transfer
Alternative risk transfer is at the forefront of developing risk solutions related to climate change, said Mr Jenner.
“An increasing number of companies have identified climate-related issues as key risk factors, yet they lack the analytical capacity to identify their exposures and the knowledge to protect against these negative effects,” he said.
AGCS has established a team called Allianz Risk Transfer (ART), primarily focusing on the energy and agricultural sectors, that conducts thorough analyses of the client’s climate risks against the background of historical weather patterns and suggests tailored – often index-based – solutions that protect against unwanted precipitation, temperature or other weather perils. Data collections have become increasingly sophisticated with contributions from an elaborate network of local weather stations, satellites and synthetically created and modelled data, said Mr Jenner.
In order to provide clients with the most comprehensive solutions, sometimes referred to as ‘all-risk-covers’, ART’s weather and agriculture experts team up with AGCS’ engineers and other industry experts in the areas of property or liability. Depending on the regulatory environment, the risk solution is often provided by the local Allianz entity or a local network partner of Allianz Group.
Stakes are high
The implications of climate change are far reaching in the future.
Left unchecked, climate change is likely to have huge economic, political and social impacts, said Mr Jenner, with implications for food and water security, health, migration and conflicts.
The increasing market impact of climate change on assets could change the way we see market-driving events, said Mr Stefan Wolf Stärtzel, climate finance analyst in resilience & sustainability, Aon.
“As companies begin disclosing climate risk, it could increase accountability and compliance to managing these risks. The materialisation of climate risks into the financial markets can have a ripple effect into different areas of our economy. We need to limit the damages these climate events can have by reducing emissions, increasing transparency of potential impact and creating a sustainable financial framework that deals with these types of impacts,” he said.
Seizing opportunities
Opportunities for the insurance sector arising from climate change are two-fold, said Mr Stärtzel, first, as risk managers, and second, as insurance capital providers. “The industry is in a unique position to understand these climate risks better than other sectors, and can use that understanding to advise clients on underwriting strategies and offer solutions that bring climate change and its impact into the foreground and assess the most sustainable way forward to keep assets insurable,” he said.
“Insurance is a well-proven instrument to deal with volatility of outcomes, from a financial perspective,” said Mr Gloor. “In consequence, we believe that these changes will spur new insurance demand. If addressed prudently in terms of forward-looking risk assessment, the insurance industry will be able to add its share to growing resilience, while also offering increased business volume. Furthermore, a transition to a low-carbon economy will provide growth opportunities for new asset classes or infrastructure projects, for example in the energy sector.”
Mr Jenner said, “We’re actively working with our customers and partners to find suitable solutions that enable a joint-path towards a low-carbon economy. For us as an insurer and investor, protecting the environment is part of our core business.”
AGCS has been a carbon-neutral company since 2012, and it plans to phase out both its proprietary investments in coal-based business and its insurance coverage of such risks by 2040.
Mr Gloor said insurance penetration for weather-related perils is still relatively low and therefore the impetus to act has been limited within the insurance industry in the MENA region. To prepare for the upcoming challenges, he said the industry needs to collaborate with partners from both the industry and academia to transparently discuss climate risks and implement strategies and products to cope with the consequences of climate change.
In the words of UN secretary-general Antonio Guterres during his opening address at the Katowice Climate Change Conference last year: “Climate change is running faster than we are, and we must catch up sooner rather than later before it is too late.” M