Integration of the latest findings in climate science into catastrophe risk modelling would increase its usefulness to society, while adopting a forward-looking approach involving climate change scenarios would also be beneficial, according to the Geneva Association.
In a report, the Geneva Association highlights that climate science and the ability to look forwards at a range of outcomes based on differing assumptions for climate change and variability, could make catastrophe risk models more broadly useful than just in insurance and reinsurance alone.
The catastrophe risk modelling industry has already revolutionised the insurance, reinsurance and of course insurance-linked securities (ILS) markets methods for assessing, pricing and managing disaster risks, but its usefulness could be broadened to impact all of society with a greater focus on climate risk.
Anna Maria D’Hulster, Secretary General of The Geneva Association, explained, “Cat modelling is more relevant than ever. As the effects of climate change become more severe, the insurance industry must keep up with market demand and anticipate future changes through the advancement of risk analytics.
“Cat models can assist insurers and policymakers develop a thorough understanding of the costs and implications of catastrophe risk. Few sectors of the economy play a role as intense in catastrophe recovery as insurance; therefore, the industry should strive to continually strengthen the predictive power of its Cat modelling capabilities.”
Maryam Golnaraghi, Director Extreme Events and Climate Risk of The Geneva Association, also said, “Building on the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, increasingly more sectors are considering physical climate risk in their core business and investing methodologies. Cat models, if properly conditioned to climate change scenarios, could be utilised to understand the impact of weather-related risk on assets, operations and investments, and to develop risk management measures to address such risk.”
The Geneva Association recommends adopting a forward-looking approach to catastrophe risk modelling to meet some of these needs, which it says could enhance the ability to stress test and analyse risks under different climate change scenarios and as a result support the development of new climate insurance product and service offerings.
This is also really important for the insurance-linked securities (ILS) market, as one of the most frequently asked questions from investors researching the ILS sector is if and how climate change can impact or affect return assumptions for portfolios of natural catastrophe and severe weather risk.
While ILS and reinsurance linked assets most commonly only have durations of between one and three years, hence are not affected by decadal changes in climate, the fact is that climate factors influence the behaviour of weather extremes, as well as the frequency, severity, and locations of storms, it is widely assumed.
Therefore, forward-looking and climate linked catastrophe risk modelling tools would be beneficial to ILS fund managers, as a way to explain how climate can influence portfolio returns, and to investors as a way to understand how the ILS asset class may be affected over the longer-term.
The Geneva Association goes even further, recommending that catastrophe risk model development should look to “embrace a systems-based thinking,” achieved through connecting cat risk models with other systems of modelling such as those in used in economic analysis, the water-food-energy nexus, as well as in infrastructure and health systems.
By aligning the catastrophe risk models with other forms of economic and financial modelling in sectors that themselves carry weather, catastrophe and climate risk, the benefits are clear and could assist with product development and the integration of risk management (and risk transfer) within other industries.
In addition, the Geneva Association notes this could help improve policymaking, planning and risk management decision-making as well.
The predictive and analytical power of catastrophe risk modelling and what that has brought to insurance, reinsurance and now the ILS market, can play a significant role in global climate resilience and as a result the integration of catastrophe and climate risk analytics can surely only bring benefits.