Munich Re: Reinsurance alone cannot absorb systemic risk of climate change

Global reinsurance giant Munich Re has said that reinsurance alone cannot absorb the systemic risk that climate change brings, citing the need for public private partnerships and government intervention.

Munich Re presented to investors and analysts on its environmental, social and governance (ESG) activities and the session included commentary on how the reinsurance company views climate change and the threat it believes it poses.

The company is taking actions on both the underwriting and investment sides of its business to limit climate change related effects, while also embracing an ESG strategy on both sides as well.

Starkly, the reinsurance firm warns that it believes climate change poses a systemic risk to the insurance industry.

Not only is climate change considered likely to drive challenging weather loss trends, or at least changes in frequency and severity, but Munich Re also believes that even a small increase in temperatures can drive a large increase in the probability of new extreme events occurring.

Analysts at investment bank Peel Hunt noted today that secondary peril losses are now exceeding peak peril losses in some years.

This weekend’s tragic tornado impacts (December 10th) served to underscore this further, as they will drive 2021 severe weather losses in the United States well above the $20 billion mark.

That leads the Peel Hunt analysts to suggest that at the upcoming reinsurance renewals, some underwriters may reduce their exposure to these secondary peril events further, as rate increases alone are unlikely to cover rising risks.

Munich Re sees two areas of exposure increase.

First, from climate change itself, driving a shift in frequency and a higher probability of extreme events.

But, just as important is changing demographics, with population density and value concentration both increasing exposures in high risk areas as well.

As a result, Munich Re sees growth potential for its natural catastrophe reinsurance business, but only if rates are adequate.

The reinsurer also noted that, in order for protection gaps to be narrowed around the world in the face of rising climate change risks, there will be a need for public-private partnerships and government intervention.

In fact, it seems Munich Re does not believe that reinsurance alone can absorb what it calls the systemic risk posed by climate change.

Meaning that the public sector needs to work with industry, in order to prevent market failures and take on risks where the private sector cannot absorb them on its own.

This also suggests a role for third-party reinsurance capital, to assist the private reinsurance market in absorbing climate-related risks and the increased exposure a changing climate could drive for the industry.

This could be especially relevant if, as Peel Hunt’s analysts suggest, re/insurers increasingly look to minimise exposure to volatility, secondary perils and climate change effects in catastrophe portfolios.

Without the support of additional capital providers, the traditional market could find its relevance wanes in the face of climate change, which would harm its reputation as the provider of capital to buffer against weather volatility.

Hence, by working with insurance-linked securities (ILS) investors, the traditional insurance and reinsurance market can improve its own ability to absorb volatility from climate related catastrophes, while enabling it to maintain its role as a protection provider and keeping more of the risk in private markets, so reducing the need for public market intervention.

“Amidst the rising frequency and severity of secondary perils it will be interesting to see whether the reinsurance industry reduces its exposures at the upcoming January renewals. What is becoming increasingly clear is that the industry’s exposure to secondary perils is likely to be re-priced, in our view,” Peel Hunt’s analysts concluded.