No immediate threat to ILS investments from climate change, says report

by Artemis on June 9, 2015

A report examining the impact climate change could have on insurance and reinsurance industry losses from Atlantic hurricanes claims that while there’s no evidence of any short term impacts, it has the potential to nearly double average annual losses in the future.

The report, titled “Climate Change and Hurricane Loss: Perspectives for Investors,” was published by Karen Clark of Karen Clark & Company and John Lummis, currently the President of Soncy Corp., where he is active as an advisor and as a private investor, focusing on the financial services sector.

The report examines the potential impact climate change has had on the frequency and severity of North Atlantic hurricanes and the resulting losses, with a view to the near and longer term effects.

The general conclusion of the three-part study is explained succinctly by Karen Clark, who said; “Climate change has had no measurable impact on hurricane activity to date, and any further near term impacts are likely to be imperceptible and have no effect on potential losses to the ILS market.”

Lummis echoed this view, saying; “While climate change poses many long term challenges for society, with respect to shorter term catastrophe reinsurance and related investments, the catastrophe simulation models, when used prudently, can still effectively represent hurricane risk.”

The report explains that the loss potential for the catastrophe market resulting from North Atlantic hurricanes is basically the same this year as it was last year, which is roughly the same as five years ago, and will most likely be the same in another five years.

Supporting the notion that, over the shorter term, “a meaningful difference in the frequency and severity of hurricanes will not be perceptible anytime soon” due to the impact of climate change.

One element that does incur increased economic and insurance industry losses after a hurricane is the rise in insured property values, notes the report, implying that this is more of a driver for increased losses to the cat market than a rise in the severity and frequency of hurricanes.

For the longer term, however, the report draws on conclusions from a similar study conducted by the Intergovernmental Panel on Climate Change, which notes that during the 21st century, “it is likely that the global frequency of tropical cyclones will either decrease or remain essentially unchanged.”

Although the report does note that while the frequency of events might not increase, the intensity could; “Average tropical cyclone maximum wind speed is likely to increase, although increases may not occur in all ocean basins.”

This implies that despite the frequency of hurricanes predicted to stay roughly the same, the intensity could rise due to increased wind speeds and rising sea levels, which might be influenced by climate change.

While none of the findings in the report are definitive, it does claim that it’s likely there will be a rise in the number of very intense hurricanes by the end of the 21st century, the type of events that are the main drivers of losses in the related catastrophe markets.

And, linked to this will likely be a rise in the amount of rainfall during the same period.

“Assuming these changes carry over to the subclass of U.S. landfalls, insured losses will likely increase as a result, though the catastrophe models cannot say anything definitive, not surprisingly given the number of factors and time horizon,” notes the report.

Interestingly, the report claims that an 11% rise in wind speed of hurricanes in the Gulf and along the East Coast could lead to almost double the amount of hurricane losses. While a 2% increase may incur a 15% increase in the annual average losses.

Rising sea levels, increased wind speeds and rising asset values are all factors that could contribute to an increase of losses from a severe hurricane, claims the report, noting that it’s possible in the longer term that climate change could exacerbate this.

To conclude, Clark said; “Seasonal predictions of hurricane activity are not that meaningful for investors because hurricane losses are driven by severity and landfall location and not frequency.  ILS investors will likely only experience losses when a severe event impacts a major metropolitan area—a rare occurrence that can happen in an inactive or active year.”

“The issue of climate change should not impair interest in the ILS market,” added Lummis.

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