Long-range weather forecasts to increase in importance for reinsurers

by Artemis on July 4, 2011

Many weather and peril re/insurance pricing decisions have tended to be made based on analysis of historical data rather than on forecasts. Historical data has always been seen as the best way to predict weather trends and assess riskiness of a specific peril in a specific geographic location. Forecasts were seen as too inaccurate and prone to error, but new technologies and a changing climate mean that long-range forecasts are increasingly being accepted and used by re/insurers.

A joint report from Lloyd’s and the UK Met Office suggests that long-term forecasting is increasing in importance for insurers and reinsurers and that trend is destined to continue as the technology improves. Given that we are experiencing increasingly severe weather disasters, much of which is put down to the changing climate, basing risk decisions on historical weather data may no longer be quite as accurate as it once was. A combination of analysis of historical trends combined with the best in long-range forecasting seems likely to become the norm.

Matt Huddleston, Principal Consultant at the Met Office said; “Recent advances in research and improved technology suggest some phenomena can be forecast months or even further in advance, such as tropical storms in the Atlantic – an area of forecasting where the Met Office has seen improving levels of accuracy over the past few years.”

Of course as anyone who keeps an eye on their local weather forecast will know, forecasting is an imprecise science and cannot guarantee accuracy. The argument made in the paper is that forecasting science has become accurate enough on some weather risks for it to be included in decisions on the riskiness of a contract.

Weather traders in instruments such as weather derivatives already use forecasting to base decisions on their purchase of derivatives for forthcoming seasons. The need for forecasting in the weather risk management sector is likely to drive scientific improvement of forecasts and the demand for increasingly long-range outlooks. It seems that forecasting is set to become more important in other risk decisions in the re/insurance industries as well.

Dr Huddleston continued: “Insurance is one of the main tools that businesses and communities have to protect themselves from catastrophic events and build resilience. This report shows that the insurance industry may increasingly benefit from the use of long-range predictions – especially in a changing climate where the past may not represent the future”.

Trevor Maynard, Head of Exposure Management at Lloyd’s, said: “Long-range forecasting methods and techniques should help risk experts and modellers refine their modelling practices and will play a growing role in the insurance market, particularly as the impacts of climate change are increasingly felt.”

Forecasts are unlikely to ever be an instrument that you could base re/insurance pricing on alone, there are so many other factors and uncertainties to consider, however they are going to play a larger role in everyday re/insurance underwriting decisions.

You can download and read the full report from the Lloyd’s website here.

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