Solar weather and geomagnetic storms a threat to re/insurance industry: Aon Benfield

Reinsurance broker Aon Benfield has published a report which delivers a timely reminder to the insurance and reinsurance industry that the potential losses from a major space weather event could cause massive economic and insured losses and the re/insurance industry needs to consider its preparation and response. Solar storm and geomagnetic activity is forecast to peak in the coming 12 months meaning the threat of a major space weather event is approaching its highest.

Aon Benfield is covering solar and geomagnetic storms in the first in a series of publications looking at what it has termed ‘pear-shaped phenomena’, low probability events which threaten high economic consequences to the re/insurance industry and broader economy should major events occur. Unlike a black-swan event, Aon Benfield says that ‘pear-shaped phenomena’ can be anticipated and therefore the re/insurance industry should take the lead in risk management and transfer of these risks.

Scientists have said that a major space weather event could cause enormous economic losses around the globe. The next peak in solar activity is scheduled to occur later this year, it follows a roughly 11 year solar cycle from solar minimum to solar maximum when sun spot activity and solar storms are at their most violent.

The impacts according to scientists could be as large as an economic loss of $2 trillion. An economic loss of that size would naturally result in one of, if not, the largest insured and reinsured losses in history. At risk are electrical power distribution networks, telecommunications infrastructure, satellites themselves and global satellite navigation systems, all systems that if damaged would cause huge business interruption to occur for years in some cases.

Aon Benfield said in the report that insurance policies and reinsurance treaties likely carry the necessary clauses and legal triggers for liability in the event of a major space weather event, but are unlikely to have been drafted with such an event in mind. The industry can adapt clauses to ensure coverage is available through contingent business interruption and extra expenses products.

Stephen Mildenhall, CEO of Aon Benfield Analytics, commented; “Insurance and reinsurance industry awareness of geomagnetic storms has grown in recent times, but accurate assessment of risk still remains in its infancy for all but a few niche sectors. The report details five major geomagnetic events that have occurred over the last 150 years, highlighting the need for a better understanding the risk management, pricing and coverage implications of this very credible type of event. We also outline some of the critical insurance issues involved in responding to the risk of geomagnetic storms.”

There are opportunities for the reinsurance, weather risk management and risk transfer sectors to develop products which could hedge against the risks of severe space weather.

Satellites are currently underinsured, with many having no insurance at all. According to Aon Benfield’s report there were 936 operating satellites in orbit, according to a 2007 estimate, having a combined value of $170 billion to $230 billion but only one-third of these are insured. There is an opportunity for the insurance and reinsurance sector to find ways to extend coverage to the uninsured satellite operators, potentially just for the peak risks of failure or damage due to space weather. A 1996 to 2005 sunspot activity cycle damaged 15 satellites at a cost of around $2 billion.

Given the large amount of scientific data and observations about solar activity it could be possible to create some kind of indexed product with a trigger paying out based on a certain level of activity and solar flares being directed towards earth. Any such product would be almost parametric in nature and so have to be calibrated to protect against the most severe and loss threatening events only.

Specific space or solar weather insurance and reinsurance contracts could be written which only provide cover for losses directly attributed to solar weather. There may already be such policies available but underwriters are likely few and far between and hence costs likely to be significant. Wordings will be extremely important in all of the above cases.

We’ve written before about the potential for space weather derivatives or solar weather derivatives and it remains feasible that solar activity levels could be hedged in a similar way to degree days in the weather risk management sectors. Given the size of the potential exposure and the low probability of events a hedge approach would be suited to many satellite operators or electrical transmission infrastructure owners.

Could a space weather catastrophe bond be created? It’s possible but would likely require some kind of dual trigger approach to link the occurrence of a space weather event to the ultimate net loss of an insurer or corporation with major space weather risk exposure. Such a trigger could perhaps be used for an industry loss warranty (ILW) as well. It’s highly likely that a risk of this magnitude would require third-party capital providers to get involved as they may have a better appetite for these rare, but potentially huge risks.

The key activity that needs to be undertaken is for insurers to complete an exercise which identifies their potential exposure to a major solar weather event. This can inform insurers policy wording and reinsurance needs and inform reinsurers where they may need to purchase retrocessional cover as well.

Aon Benfield’s paper can be downloaded in PDF format here.