Risk transfer a key tool in climate change adaptation: Nephila report

Risk transfer is often overlooked in discussions relating to climate change and adaptation to it, as instruments including weather risk transfer and catastrophe reinsurance are able to send price signals to help public and private sector entities better understand the economic value at risk.

This is according to a new report sponsored by Nephila Climate, the weather and climate risk transfer focused unit of the world’s largest insurance and reinsurance linked investment manager Nephila Capital.

The report takes a look at what has happened in the risk transfer, insurance-linked securities (ILS) and reinsurance world in relation to climate change and suggests that the embedding of risk transfer within public and private organisations management of climate exposure would be beneficial.

The aim is to get risk transfer firmly into the main-stream discussion of climate risk and adapting to it, topics we have been covering regularly here on Artemis for many years now, but which are not widely covered elsewhere.

“So far, media coverage of this topic has largely missed a key strategic consideration for addressing climate change: risk transfer,” explained Barney Schauble, chairman of Nephila Climate.

“Innovative weather and catastrophe risk transfer coverage mechanisms have evolved over the last 20 years and are now viable tools for confronting climate change in both developing and mature economies,” he continued.

Taking a look at how instruments from catastrophe bonds to weather derivatives have been used to channel efficient risk capital to back climate related exposures, the report explains the opportunity for entities from governments, to corporations and even farmers to embrace risk transfer and embed it within their climate change adaptation planning.

The report finds that some sectors of the public and private economy are already embracing risk transfer for their climate exposures such as the: integration of risk transfer into developing nation adaptation strategies; the embedding of risk transfer into the strategies of public infrastructure organisations, such as water utilities and transit agencies; and that increasing numbers of publicly held corporations are considering risk transfer for climate change adaptation.

The report also concludes that by embracing risk transfer organisations can help themselves by gaining insights into the economic value of the climate related risks they hold, as weather risk transfer, and catastrophe insurance or reinsurance instruments can send all-important price signals.

It’s only as organisations gain an appreciation for the potential magnitude of their climate related exposures that they are often compelled to accelerate adaptation efforts, making risk transfer a beneficial piece of the adaptation strategies and plans organisations can put in place.

Nephila is keen to promote the value of weather and catastrophe risk transfer and the report states that outside of the risk markets, “there is still limited awareness of what a weather risk transfer (WRT) contract or catastrophe instrument is and why it has such important value.”

“As climate change drives more interest in mitigating and hedging growing risk exposure, and as word gets out how industries like electric power, agriculture, and renewable energy have hedged weather risks in a productive way for over a decade, it is a reasonable hope and expectation that WRT and catastrophe coverage can be successfully and cost- effectively used for climate change adaptation by a wide range of public and private organizations,” the report concludes.

Barney Schauble of Nephila highlights that the managers job in the insurance-linked securities (ILS) market is to “match institutions who are seeking non-correlated investment strategies with organizations that want to reduce their exposure to weather and catastrophe risks.”

“This simple concept was the basis for the insurance- linked securities (ILS) industry, and it’s grown from virtually nothing (when we were founded in 1998), to a point today where ILS is the source of about 15 percent of reinsurance risk capacity globally,” Schauble of Nephila further explains.

While the extent climate change influences severe weather and climate related natural catastrophes remains uncertain, Schauble notes that climate science is increasingly clear on the fact that climate change is expected to drive certain extreme weather events to become more frequent and more destructive.

Hence the role of ILS, in matching investor capital with risks can both provide the relatively uncorrelated returns institutional investors seek, while protecting organisations and even countries against the threats of severe weather and climate exposure, providing important capital buffering to support adaptation at the same time.

Schauble explained, “We see this as a resilient, long-term, non-zero-sum market. Institutions can achieve the results they want, improving their portfolios by investing in insurance-linked securities, the performance of which is not correlated with broader financial and alternative markets; at the same time, we can use that capital to provide protection against weather and climate risks for vulnerable communities and businesses.”

That underscores the role the capital markets have to play in the provision of weather and climate related risk capacity, and highlights why ILS capital can become a key facilitating tool to support adaptation to climate change.

Also read: Capital + tech + data can help address climate risks: Schauble, Nephila.

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