NZ Super Fund shuns wildfire exposed ILS as mispriced due to climate

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The New Zealand Superannuation Fund (NZ Super Fund) has rejected any investments into wildfire insurance and reinsurance within its insurance-linked securities (ILS) allocations, saying that because of climate change it feels the risk is mispriced.

nz-super-fund-logoIn addition, the NZ Super Fund has also said that it believes that pricing should be higher for other natural catastrophe risks, such as tropical cyclones and wind-related loss exposed insurance or reinsurance contracts.

The pension fund has undergone a review of its portfolio and released a climate change report detailing how it manages and assesses climate-related risk and opportunities in its portfolio.

With investments in insurance-linked securities and other reinsurance-linked investments through some of the market’s leading dedicated ILS fund managers, the NZ Super Fund has now taken steps to analyse its ILS market natural catastrophe exposure through the lens of climate change.

“Climate change is an immensely challenging issue for investors, businesses, governments and communities all around the world,” explained NZ Super Fund CEO Matt Whineray.

“The NZ Super Fund operates with a long-term horizon, meaning we must factor in the impacts of climate change on the markets we invest in and the businesses we own. As the global energy system transitions away from fossil fuels, some assets might become obsolete, uneconomic or lose value. Similarly, changing weather patterns and extreme events might expose other investments to increased physical risks.”

The pension fund said that it recently undertook review of natural catastrophe risk in its investments and as a result of this has “changed its view of the attractiveness of this investment on the basis of climate change.”

The NZ Super Fund further explained, “We formed a view that the main catastrophe risk modelling agencies do not fully incorporate climate change considerations into their models.

“To compound the problem, the science is playing catch-up, demonstrated by the fact that new studies cast the situation in dire terms. In short; a) it is reasonable to believe that the probability distribution of catastrophe incidence and severity of insured losses does not fully represent current known risks and b) known downside risks are increasing as scientific understanding of climate change improves.”

How well the main catastrophe models cover climate change related risks in their software is increasingly a topic of discussion in the marketplace and among climate focused institutional investors.

As a result, it appears there could be significant opportunities for incumbents or new entrants to provide a better way to analyse portfolios of catastrophe risk through a climate change related lens at this time.

The NZ Super Fund continued to explain, “Our analysis suggested that wildfire risk was not being priced properly so we decided to exclude it from our investments as allowable within portfolio construction and contractual frameworks.”

So no more wildfire exposure in the pensions ILS allocations, which means aggregate catastrophe bonds and reinsurance contracts, as well as most quota shares or sidecars would be out of the question.

As a result, it’s likely the NZ Super Fund will be working with ILS fund managers that can provide a dedicated account, focused on the types of catastrophe risk it is still prepared to accept.

But the NZ Super Fund’s discomfort with pricing in ILS and broader insurance or reinsurance goes further than just wildfire exposures.

The fund explained, “For other risks, such as those stemming from tropical cyclones and wind-related loss, we believe that it is still possible to price risks despite the impact of climate change; we just feel that the reward for covering these risks should be higher.”

As a result, the investor said it has “adjusted the expected loss factor we apply when assessing the attractiveness of these investments.”

It’s worth noting that the NZ Super Fund’s analysis of catastrophe risks was undertaken in late 2019, so it is now possible that surging pricing in reinsurance may increase the fund’s appetite for some of these risks.

Whether wildfire exposed ILS get to a pricing level where the fund feels fully compensated for the climate change related exposures it is assuming remains to be seen.

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