The insurance and reinsurance sector can benefit from increased disclosure of climate-related risks and increasing scrutiny from regulators is also expected to ultimately benefit the industry, Moody’s has said, which we’d suggest will include much-needed benefits for the insurance-linked securities (ILS) market as well.
Climate-related risks and whether they are being fully-accounted for in the pricing of insurance products, let alone reinsurance and ILS arrangements, is an increasingly hot topic.
The recent winter storms in the United States are set to drive more scrutiny from investors backing traditional insurance or reinsurance companies, as well as ILS funds, as yet another tail event falls far outside of the typical modelled bounds for an industry loss.
Questions will be asked, as they rightly should be, both about the potential for climate to have been a factor, as well as why the state of the infrastructure that failed might not have been considered in the modelling.
But as another loss event laden in uncertainty, the main question lies in whether the premiums were compensating for the risks being taken, and here, without greater disclosure around the insurance, reinsurance, or ILS transaction itself, it’s very hard for underwriters to be entirely certain where these issues may arise.
Which is why the subject of climate-related risks and their disclosure stands to benefit the industry.
Not just because it will enable better informed choices on counterparties and risks to be underwritten to be made, something that’s key for insurance-linked securities (ILS) funds wanting to promote their offerings as environmental, social and governance (ESG) compatible strategies.
But because increased disclosure of any kind ultimately means better underwriting data, to aid in decision-making, pricing and portfolio allocation decisions, all of which are not just critical in understanding potential climate-change related exposures, but also catastrophe-related and risk exposure in general.
“Increased disclosure of climate-related risks will help insurers measure, benchmark and manage their exposure to climate risks,” Brandan Holmes, VP-Sr Credit Officer at Moody’s Investors Service explained. “It will also encourage them to consider climate risk and sustainability more rigorously in their investing and underwriting decisions, improving their overall risk management.”
Close regulatory scrutiny is an important part of this, as it can be a significant driver for change in an industry that has often held its disclosures close and kept them limited.
While data is still king and will remain closely held in this industry, enhanced disclosure of climate-related risk factors will benefit all tiers of the insurance, reinsurance and ILS market, enabling better decisions to be made and greater certainty to be gained on the potential performance of portfolios.
It won’t erase the chances of big model-miss loss events occurring. That doesn’t seem likely to go away and in fact may only get worse, given the way society and economies are developing and modernising apace.
But disclosure will give more data and information to base underwriting decisions on, which can only help in narrowing the gap between modelled and actual losses, so reducing the seemingly increasing uncertainty load seen in many weather-linked industry loss events.
Moody’s said, “Scrutiny of climate risk is positive for insurers because it will push the industry to better evaluate and monitor climate-related threats.”
This is precisely what investors want to see in ILS, as they are keen to understand what work is being undertaken to try and ensure climate-related risk factors are included in fund manager decision-making.
Regulators expect better disclosure, stress-testing for climate related events, board level climate focused decision making, as well as ESG practices to be integrated in business processes.
Embedding disclosure at the heart of the risk industry, which seems assured to happen given the regulatory focus, can only aid in ultimately giving investors more confidence that climate-related risks are being considered and steps being taken to account for them and most importantly to ensure they are priced for.
Disclosure, alongside all the other regulatory avenues of progress, promises to also make the shift to ESG compatible strategies less challenging for ILS fund managers as well, as the submissions they receive from cedents should, in future, come with a much better level of climate disclosure and underwriting data to support that.
As pressure from investors and regulators rises on corporations, insurers and reinsurers to enhance their disclosures around climate risk, this should naturally drive improved disclosure for the ILS market.
This could be a significant benefit for the ILS market, often sitting near the end of a long insurance and reinsurance market chain along which disclosure can tend to become murkier, or more clouded.
Lifting those clouds and ensuring ILS funds and investors have access to more granular data with all the necessary climate-related exposures, can help make qualifying ILS funds as truly ESG appropriate a more readily achievable task.