Scientific research improves extreme weather planning for insurers and commodity markets

by Artemis on July 26, 2011

The financial services sector, especially insurers and the commodity markets, can make better risk decisions thanks to increased scientific knowledge about the climate phenomena, El Niño and La Niña, according to a new research report commissioned from the Met Office by the Lighthill Risk Network.

“The importance of El Niño and La Niña events is two-fold: they shift the risks of damaging hazards in recognisable ways and they are predictable about six months in advance,” state authors from the Met Office in their report, Global Impact of El Niño and La Niña Implications for Financial Services. “Clearly the periodic reduction of risk offers economic and societal benefits that, if known in advance, could be exploited.”

Due to the implications and risks for property, agriculture and transport infrastructure, Lighthill Risk Network asked the Met Office to examine the cycle of El Niño and La Niña episodes and the impacts that are most relevant to the finance industry globally, with a particular focus on severe rainfall and tropical storms.

In winter 2010/11 during a major La Niña episode, the state of Queensland in Australia suffered flooding losses estimated at $5.5bn, which resulted in the devastation of their sugar cane crop, disruption of the coal mining industry and wheat transport, and extensive damage to property.

El Niño and La Niña events form in the tropical Pacific ocean, where strong and extensive interactions between the ocean and atmosphere can lead to warmer or cooler than usual ocean conditions that last several months and have widespread effects. They tend to have opposite effects. There has been found, for example, a pronounced correlation for there to be fewer Atlantic hurricanes during an El Niño event and many more during La Niña events.

Both El Niño and La Niña are associated with climatic shifts that affect regional temperature, rainfall amounts and wind patterns across the tropics and mid-latitude regions.

It’s not all bad news though and there can be positive effects. While some areas may experience more severe weather there are others which are likely to have less disturbed weather conditions. So one region may suffer heavy crop losses due to flooding or drought while another region may experience bumper crop yields due to perfect growing conditions and be able to command higher prices.

Negative impacts of the climate phenomena include significant damage to property, agriculture, especially crops, forestry and transport infrastructure. For property insurance and the reinsurance market, the most significant impacts are associated with damage caused by precipitation induced flooding or severe storms. Drought as a result of high temperatures and low rainfall produces low crop yields and can lead to widespread wildfires.

The best documented impacts are those associated with the very strong El Niño event in 1997/98, which was followed by an extended La Niña episode covering the next two years. US agriculture sector losses from the El Niño were estimated at $1.5-$1.7bn and those from the subsequent La Niña between $2.2 and $6.5bn.

In Kenya, the El Niño damages were estimated at 11% of the countries GDP. Conversely, La Niña caused drought damage to the extent of 16% of GDP in each of 1998/99 and 1999/00 financial years. While these impacts were unusually large, they give an idea of the range of consequences – and they may occur again, states the Met Office.

While the potential for loss caused by these weather variations is impossible to predict the re/insurance and weather risk management markets have the potential to soften the blow for property owners, agricultural and industrial concerned sectors. Climate variability is a difficult phenomena to hedge effectively as the impact varies so greatly but this just underscores the importance of having a robust scientific research effort to help effective weather risk management and re/insurance programs be put in place.

You can download the full report in PDF format here.

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