Climate threat needs capital response, but industry has to give it confidence

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The economic consequences of climate change may prove particularly severe for insurance and reinsurance companies in the property and casualty (P&C) space, presenting both a threat and an opportunity, but the latter may require access to capital to take full advantage of it.

climate-change-adaptationRecently, rating agency Moody’s reiterated its stable outlook for the global P&C insurance sector, but noted that severe weather, catastrophe and loss trends related to climate exposures pose a potentially increasing threat.

While there remains some debate over climate change and how it should be factored into the sector’s view of risk, the impacts of severe climate linked events cannot be doubted or underestimated.

In the insurance and reinsurance sector there is a growing consensus that things are getting worse, in terms of the frequency and also severity of certain atmospheric type perils.

No quarterly earnings season of the major insurance and reinsurance firms goes by without a number of CEO’s explaining that storms are becoming more intense, convective weather more prevalent, rainfall more extreme and temperatures more impactful.

Clearly the industry is aware of the threats posed by our changing climate and Moody’s notes that claims costs are trending higher as well.

For now though, the P&C sector is managing these claims through the use of catastrophe modeling, underwriting and reinsurance, but Moody’s believes more capital may be required should the trend towards increasing severe weather and catastrophe claims continue.

“P&C insurers are exposed to the economic consequences of climate change, mainly through its unpredictable effects on the frequency and severity of weather-related catastrophes such as hurricanes, floods, convective storms, droughts and wildfires,” Moody’s Vice President Bruce Ballentine said.

It’s a threat to their earnings and solvency of course, but also provides an opportunity, as insuring the world against climate related perils is clearly the domain of the P&C insurance and reinsurance industry, as well as insurance-linked securities (ILS).

“Such shifting perils also represent an opportunity for P&C insurers to provide additional coverages and other risk mitigation products for clients,” Ballentine explained.

Loss cost inflation and the risk that poses to global P&C insurers features heavily in Moody’s assessment of the sector though.

Should loss costs rise at a faster rate than pricing trends, then Moody’s would be likely to consider the sector as moving into negative territory.

In addition, should the P&C sector significantly increase its exposure to catastrophe losses, that too could shift the sector outlook to negative.

In a world where climate change may be driving rising catastrophe and weather claims, while increasing exposure at the same time, it seems likely reinsurance and other forms of capital are going to be required to support P&C insurers and to ensure they don’t have to shrink their books, in the face of these rising risks.

Of course, rates are rising right now, relatively meaningfully in the commercial and large ends of P&C insurance, particularly in the United States.

But will those increases account for the potential future loss costs associated with climate change linked exposures, or could claims runaway from the P&C sector if it fails to keep its pricing keen? Do they even account for the losses already suffered?

At a time when there are growing fears over rising exposures and claims inflation from climate related perils, it seems inevitable an increasing need for reinsurance will be seen.

But, should the impacts of climate related perils really accelerate, while rating agencies like Moody’s get increasingly negative about P&C companies as a result, it seems traditional reinsurance alone may not be sufficient and capital in other forms could be required as well.

Cost of capital will become increasingly important too, as re/insurers will have to pay more for their protection and capital if the accelerating loss trends related to climate exposures continue.

Capital will want to ensure it is compensated though.

Already some ILS investors are asking very serious questions about the industries ability to price for the rising impacts related to climate change and if the industry cannot demonstrate it is adequately accounting for climate related risks, then it could find some of its capital more reluctant to support it.

In fact, Moody’s warns that in extreme cases climate risks will limit the availability of capital for the most-exposed sectors and geographies. This could result in a worsening protection gap, as certain risks become uneconomical to insure.

The insurance, reinsurance and risk transfer industry has a responsibility to price risk accurately.

It is only by sending clear and accurate signals on the price of coverage that ceding clients (and consumers) can be aware of the potentially rising costs of their climate exposure, motivating them to enhance their resilience as a way to increase affordability of the protection they need.

If trends continue to worsen then capital will certainly be required to address what may prove to be a rapidly widening climate risk protection gap.

But if the industry hasn’t sent the right signals on price and demonstrated its efforts to cover its loss costs, then the capital providers (including major ILS investors) might be more hesitant to back a sector which, in some quarters at least, is seen as failing to price in the full and growing risks of its climate exposure.

There are obviously significant opportunities in ILS to provide the large sums of financial risk transfer protection to help the world in its adaptation to face growing climate related risks.

Giving investors confidence that climate exposure is well-understood, being dealt with effectively and most importantly priced for, is only going to become more important down the line.

ILS funds, insurers, reinsurers and importantly risk modellers, all have a significant job to do.

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