Insurers and reinsurers coping with extreme weather threats: S&P

The insurance and reinsurance industry is coping with the increasing number and frequency of extreme weather events and has processes in place to monitor the impact of climate change on weather losses, says rating agency Standard & Poor’s.

In a report published yesterday S&P looks at how insurers and reinsurers respond to the increase in frequency and severity of extreme weather events and how climate change is factored into their risk management and underwriting decisions.

“We believe the industry has been, and remains, well prepared to deal with weather events of the magnitude the world has been experiencing in the past two years. For that reason, the ratings impact of these natural catastrophes has been limited,” comments Standard & Poor’s credit analyst Miroslav Petkov, in the report.

S&P says that insurers and reinsurers have been generally able to cope with the impacts of severe and extreme weather over the last couple of years due to their risk diversification strategies as well as effective underwriting, risk management and risk mitigation.

However, events in recent years while severe, have not resulted in historic sized losses, says S&P, and remained well within insurers and reinsurers expected loss levels and within their excess capital limits.

S&P says that it would not expect to level widespread rating changes on the insurance or reinsurance industry unless weather-related industry losses exceed the amount expected from a 1 in 250 year return period loss.

S&P notes that climate change is not explicitly factored into pricing or modelling of risks yet by the insurance and reinsurance industry. However it believes that re/insurers have the processes in place to monitor the impact of climate change on weather events and then to adjust premiums based on any gradual increase in weather-related claims in the future.

Even those insurers and reinsurers that have invested the most in understanding climate change and its threat to the industry do not yet explicitly allow for it in their pricing and modelling, said S&P.

Despite the growing consensus among scientists that climate change will result in more impactful weather events and ultimately greater economic and insured losses, there remains uncertainty about the exact impact. As a result, S&P does not expect the insurance or reinsurance industry will directly allow for the impact of climate change until consensus emerges over the potential impacts.

“Our view is that climate change is another factor contributing to the challenges of modeling extreme weather events,” Petkov said. “For that reason, we take a favorable view of re/insurers that consider how climate change, despite its uncertainties, may affect extreme events in capital modeling and exposure management.”

S&P notes that any sudden spike in the frequency or severity of weather events could test the insurance and reinsurance industry. Hence the need for both insurers and reinsurers to make sure they are at least aware of the potential worst case scenario for their portfolios of risk should the changing climate push weather extremes to the maximum degree.

In the future risk models will likely begin to factor in views of the potential futures for our climate depending on different models or forecasts for change. At this time insurers and reinsurers will be able to take a range of views on the long-term impact to regions and portfolios of risk and may begin to factor in some pricing increases.

Some insurers and reinsurers are already doing this in-house, with their own analytics and modelling teams. S&P says that it takes a favourable view of those that consider the additional challenge that climate change poses to risk modelling and their exposure management.

S&P notes that the industry would like more certainty in how it should factor climate change into its models, pricing and underwriting processes. Without certainty it is very difficult for insurers and reinsurers to do anything other than react to weather loss trends and adjust pricing based on loss experience.

With the recent growth of multi-year covers in reinsurance, stimulated as a response to alternative reinsurance capital and insurance-linked securities such as catastrophe bonds where multi-year is the norm, the need to have a more accurate way to factor the changing climate into pricing is heightened.

Climate variability has increased, whether change related or not, we now experience years of extremely high losses from weather events and well below normal losses and the extremes seem to be growing in severity on either end.

It’s impossible to say whether this is climate change in action or simply climate variability, however the need to be able to forecast and model the potential variation in losses from year to year as the climate adjusts is important to both insurers and reinsurers.

It’s also important to the ILS market, with investors asking questions of ILS managers about climate change, variability and how these factors could affect the expected loss of an investment or fund. These questions are going to become louder and more frequent as the ILS market and use of instruments such as cat bonds continue to grow.

S&P says that it stands ready to adjust its rating methodologies if further climate change impacts and threats to insurance and reinsurance markets become apparent:

We consider that the re/insurance industry is well prepared to deal with possible gradual increases in extreme weather events, whether or not they’re linked to climate change. As such, we don’t expect climate change per se to have a ratings impact over the next three to five years, unless it causes a sudden increase in the number and magnitude of extreme events. Meanwhile, we will continue to follow developments in the field of climate change. If needed, we’ll revise our base case assumptions and capital stresses for weather-related losses and reflect them in our rating process.