Corporate focus on climate & weather to result in more risk transfer

by Artemis on May 27, 2014

With extreme weather & climate related losses rising fast, as exposures grow, more violent extremes occur and industrialisation of emerging economies continues, investors and regulators are set to place increasing importance on corporate climate risks.

Rating agency Standard & Poor’s has published a report looking at the growing need for companies and corporations to assess and mitigate their climate related risks. Extreme weather is recognised as the leading climate related risk to companies, with climate event risks seen to impact both short-term liquidity and long-term debt financing, resulting in an increase to credit risks.

S&P says that the increasing frequency of severe climate and weather events is putting pressure on companies to identify, quantify and disclose their material exposure to these risks. Investors and issuers, who are already recognising the impact of carbon related risks on companies, are not as aware of climate and weather risks thus far, but this is set to change.

S&P expects a greater level of importance will be placed on companies exposure to extreme weather and climate events, by regulators and investors, as an indicator of company performance. This will require a proactive response to risk management and also to the procurement of insurance coverage, with how well protected companies are likely to become a real insight into their exposure.

Of course this could result in an increasing reliance on insurance covers to protect companies against extreme weather and climate events. This might be in the form of traditional property insurance covers, supplemental insurance targeting specific perils or even in corporate catastrophe bond issues.

An increase in scrutiny of corporations and their exposures to weather and climate related risks will mean an increased need for risk management, insurance and risk transfer protection for these companies. As scrutiny increases so will the available budgets to provide risk transfer and insurance solutions, which in turn should result in a greater need for catastrophe and weather reinsurance cover as well.

The capital market side of reinsurance, with instruments like catastrophe bonds at its disposal, should be well-positioned to benefit from any increase in focus on weather and climate risk management at the world’s largest companies and corporations. Cat bonds are equally applicable to the weather and climate risk transfer needs of corporates, as they are to insurers and reinsurers.

The example set by the New York Metropolitan Transit Authority last year, with the innovative MetroCat Re Ltd. storm surge catastrophe bond, shows that cat bonds and ILS can be effectively used as part of a corporate insurance program. MetroCat Re is the latest and perhaps highest profile of a series of corporate catastrophe bonds which have been issued since the cat bond market emerged in the 1990’s.

The first corporate cat bond, Concentric Ltd., was issued in 1999 on behalf of the landowner of Disney Land Tokyo. Concentric featured a parametric trigger, structured around concentric circles emanating outwards from the theme park. Koch Weather then sponsored Kelvin Ltd., a cat bond type issue in late 1999 which transferred various weather derivative risks to capital market investors.

Another notable corporate cat bond was Studio Re Ltd., sponsored by Vivendi Universal SA in 2002 to protect it against earthquake losses on a parametric basis. In 2003 FIFA transferred some of its world cup event cancellation risks in the Golden Goal Finance Ltd. cat bond transaction.

Electricite De France (EDF) is a more recent sponsor, with the 2003 Pylon Ltd. cat bond followed up by the Pylon II Capital Ltd. bond in 2011. The East Japan Railway Company also sponsored a corporate cat bond against earthquake losses called Midori Ltd. in 2007. Another innovative corporate cat bond deal was Hoplon Insurance Ltd. from MyLotto, which transferred the risks of large lottery winnings depleting its capital base.

So as you can see, there have been a number of corporate type sponsors, largely using index or parametric triggers not just to protect against catastrophes but also protecting against capital loss, cancellation risk and weather extremes. The application of the catastrophe bond structure, with its binary trigger and access to capital market financing to help spread sponsors risk could be applied to many corporate-side exposures in future.

There are a multitude of risks which could be transferred to the capital markets using a cat bond type structure, featuring a trigger based on an index, parametric factor or even perhaps on a companies own losses (so a corporate indemnity trigger). There is no reason that we could not see a proliferation of such deals in future, as the insurance linked investment market looks to become more of a risk linked investment market. The investors in the ILS space are not just looking to access insurance portfolio based risks, they are also keen to access risk directly if it is modelled, can be sufficiently understood and priced accordingly.

S&P says companies that do not plan for climate and weather event risks may find their corporate credit quality suffering. The report examines how climate related risks can damage profitability, restrict cash-flow and impair asset values of companies, weakening their liquidity positions and compromising their ability to raise capital.

The inability to raise capital is another issue that the catastrophe bond is well positioned to assist with. Consider an industry where funding is critical to meeting company goals and any failure to meet these goals harms the ability to raise follow-on capital. A catastrophe bond structure could be used to transfer the risk of failing to reach key milestones, thus ensuring a source of funding at just the time a corporation requires it.

With climate change raising climate risks all the time and increasing the severity of weather events, the outlook for corporations is indeed likely to require them to be much more in control of managing their climate risks. This will require greater levels of insurance protection, supplemental insurance products targeting weather and catastrophe risks, use of weather risk management tools and techniques and will ultimately result in greater amounts of risk transfer into the reinsurance and possibly capital markets.

Investors will not support companies which do not protect themselves against these climate and weather risks as readily in the future. As a result the onus will be on companies and corporations to proactively manage and transfer their risks and the focus will be on insurance, reinsurance and the capital markets to provide risk transfer options and capacity to support this.

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