The Big Question: How do we determine the level of climate risk and how are companies adapting to a carbon neutral future?

With Ming Li, global head of Catastrophe Modelling, Acrisure Re.

This has been a truly appalling week, given the devastating earthquakes in Turkey and Syria, which have caused extensive suffering and loss of life. As I write this, the death toll stands at some 15,000, but is almost certain to rise further as the true extent of the damage caused by the tremors and their aftershocks in the region becomes clear. The international aid response has now mobilised after Turkey issued a global appeal for help.

Given such news, one hardly needs reminding of the appalling cost of natural catastrophes. Yet accurately determining the level of risk and associated costs of nat cats lies at the heart of what our industry does, and nowhere is this more challenging at present than with regard to climate risk. 

As Munich Re indicated last month, Hurricane Ian in the United States and floods and Australia helped to make 2022 one of the costliest years on record for natural disasters, warning that climate change is making storms more intense and frequent. Indeed, according to the reinsurer, losses from natural catastrophes covered by insurance totalled around $120 billion last year, similar to 2021, though short of 2017’s record damages. The annual tally by Munich Re is higher than the average of $97 billion in insured losses over the previous five years and exceeds an initial estimate of $115 billion released at the end of 2022 by Swiss Re. Scientists have suggested that events in 2022 were exacerbated by climate change and that there is more to come as the Earth’s atmosphere continues to warm through the next decade and beyond. 

Indeed, according to a recent report from Allianz Global Corporate & Specialty (AGCS), natural catastrophes are the largest driver of corporate insurance losses in the US. And with climate change increasing the frequency and severity of extreme weather events such as hurricanes, floods and wildfires, businesses have to assess and quantify these factors with increasing urgency and accuracy as part of their corporate planning and risk assessment. 

Ian Summers, Global Business Leader, AdvantageGo

According to Ming Li, managing director and global head of Catastrophe Modelling at broker Acrisure Re, there are very few experts who would not name climate change as one of the biggest potential risks of 2023. But what is the level of that risk, he asks?

“For the insurance industry, the impact of environmental risk is arguably three-fold. What is the estimated direct risk or physical risk from climate change? Second, to what extent are companies adapting and influencing transition to carbon neutral future? Finally, what assessment needs to be made of the need to change either the models or the way we read climate data?”

One potential answer to determining the level of risk, says Li, might be cat models. But while such models are immensely valuable, he suggests, a lot of their data does not include climate change, nor do they contain an appropriate legacy of data which can help us.

What is known, however, according to Li, is that the direct risk and physical risk from 2017 to 2021 is an enormous $100bn+ on average each year, which is almost double the average for the previous five years, and 2022 is another $100bn+ year, mostly driven by Hurricane Ian. Significantly, he also points out that there is increasing evidence that climate change is having a lasting effect on the insurance industry as a whole.

“While the industry is putting considerable effort into research, a consensus is yet to be reached on the best practice to incorporate climate change in cat risk modelling. This can be due to the localisation of the impact of climate change, especially when there is a tendency to blame everything on climate change, though in some cases we can’t tell with confidence whether it is climate variability or long-term changes.”

“The confidence levels of how climate change affects different perils varies considerably. There is higher confidence for flood and wildfire, for example, and for insurers’ the impacts on sea levels and regions pose deep challenges as climate change makes risks more and more interconnected, forcing the hand of old insurance assumptions of certain risk independence.”

In future, Li suggests, underwriting practices will need to adapt in light of this to evaluate the current products in portfolios and their associated risks. In the same vein, he adds, pricing practices, specifically pricing models, may no longer be adequate given the possible, increasing frequency and severity of cat risk or to tailor products which either fit the evolving market or identify necessary exclusions in policies.

The second challenge, according to Li, is the question of how insurance companies are adapting, influencing, and investing in transitioning to a carbon neutral future across the industry. As he points out, transition risk can include policy risk, market risk, and reputational risk, which is vital in the context of the regulatory framework and requirements of ESG, now incorporated into the ratings of AM Best and other major insurance ratings agencies.”

“At the same time, we can expect to see heightened investment as the sector invests heavily in the carbon neutral space and ensuring its portfolios are clean. The simple facts remain, however, that while other sources of clean energy are increasingly available, they lack the capacity and strength to withstand the scale of energy the world needs.”

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