Insurers sleepwalking into climate disaster

Insurers sleepwalking into climate disaster

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The potential for climate change induced by ocean warming to disrupt the insurability of catastrophe risk is seriously under-estimated by the insurance industry, according to research from the Climate Risks and Insurance working group of the international insurance think tank The Geneva Association.

The lead author of the Geneva Association study, Falk Niehorster (of the Risk Prediction Initiative of the Bermuda Institute of Ocean Science), warns that traditional modelling approaches, which are solely based on analysing historical data, fail to estimate today’s hazard probabilities. Niehorster believes a shift from historic to predictive risk assessment methods is needed because hazard probabilities are becoming more and more ambiguous. In the report he calls for scenario-based approaches and tail risk modelling to become an essential part of enterprise risk management.

When considering global warming, most people think of the atmosphere, not of the oceans. But the oceans are the principle conveyor of energy around the planet. Because they’re the main source of water to the atmosphere, the oceans largely determine our weather patterns and provide the energy for the development of extreme events, the report says.

“There is new, robust evidence that the global oceans have warmed significantly,” said John Fitzpatrick, secretary general of The Geneva Association. “Given that energy from the ocean is a key driver of extreme events, ocean warming has effectively caused a shift towards a ‘new normal’ for a number of insurance relevant hazards. This shift is quasi irreversible—even if greenhouse gas (GHG) emissions completely stop tomorrow, oceanic temperatures will continue to rise.”

Socio-economic factors to do with the increasing wealth of individuals and the increasing concentrations of development and therefore risk in coastal areas and on floodplains is driving up insurance loss costs.

A lack of historical and observational data coupled with a series of competing theories amongst scientific models means that the return periods for climate-related events are volatile. The report says it is difficult for insurers to price risks today based on data from the past adjusted for these dynamic upward cost trends.

The report identifies three factors that influence loss potentials:

- It says that greater volumes of water mean greater risks. Thermal expansion of the oceans combined with the melting of continental ice shelves and glaciers has increased global sea levels by around 20cm over the last century, a rate that is accelerating. Not only do rising sea levels increase the risk of flooding or the potential impact of storm surges, but they also decrease the protective lifespan of coastal infrastructure such as the Thames barrier. A higher sea level also increases the damage potential from geophysical events because the risk of inundation is greater. Whilst the probability of a tsunami is not increased, the damage caused by one is.

- A warmer atmosphere contains more water and therefore more energy. This has the potential to increase the intensity of extreme events and associated precipitation. This greater intensity increases the loss potential of natural catastrophes.

- The effects of ocean warming on large-scale climate phenomena are currently unknown, the report goes on. But it is likely that the warming of the oceans will affect large-scale climate patterns such as El Niño, various monsoon systems or the North Atlantic Oscillation. However due to the long timescales of ocean dynamics and the relatively short length of observational data, the effects of those changes on catastrophic risk are therefore currently unclear.

The report provides two key areas for addressing this challenge. First, insurers should contribute more to the development of risk estimating science, especially using dynamic modelling approaches to estimate time-dependent medium-term outlooks in combination with scenario based approaches.

Secondly, governments and the private sector need to increase the resilience of communities by managing risks through a series of means, in particular building resilient infrastructure, a topic covered in the Geneva Report Insurers’ Contribution to Disaster Reduction – A Series of Case Studies, .

London market insurers vulnerable to climate change impacts  

Meanwhile a new study from PwC commissioned by Defra, which forms part of the UK Government’s research for the Climate Change National Adaptation Programme (NAP), suggests that the London insurance market faces big climate change related losses by virtue of its international portfolio. The study calls for insurers to take action to assess their level of risk and invest to develop new solutions, services and skills.

The findings are from a study that PwC says goes further than previous reports by examining both the opportunities and threats from projected climate change overseas, and comparing these with those linked to climate change in the UK. The study considers the projected impacts in the 2020s, the 2050s and the 2080s.

It is not just about underwriting, the report says. As institutional investors, global insurers could also see devaluation of asset value from extreme weather events, not just from physical assets but also economic disruptions that affect the performance and equity returns of companies insurers invest in.

Domenico del Re, PwC’s catastrophe risk modelling expert, said in a statement that with some 30% of UK premium income sourced overseas, the insurance sector cannot afford to not think strategically about the changing risk landscape. “The report shows how certainties and uncertainties of future climate can be factored into insurance business decisions made today.  The UK has the advantage of having centres of excellence in both climate change and insurance risk, and this report emphasises how they must come together to keep the industry leading edge.”

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