Navigating the storm: Reinsurance’s vital role in climate change resilience

By Martin Greenberg

From the raging wildfires in Canada to the devastating floods in Turkey, Greece, and Bulgaria, the dire consequences of accelerated climate change are growing increasingly – and expensive. Billion-dollar storms have already cost the US over $57 billion this year in damages alone. And the year isn’t over yet.

But this climate crisis has been heating up for decades. Over the past 30 years, insured losses from extreme weather disasters have shot up by an astounding 250%. Yet somehow, only a mere 8% of insurers are actively adjusting. It’s more common for insurers to seek assistance from reinsurers to mitigate these escalating financial impacts.

However, the combined severity and frequency of today’s natural catastrophes are making it harder for reinsurers to foot the bill. Given the critical role they play in evaluating climate risks and establishing adaptation measures, the reinsurance industry’s pricing structures and risk management strategies must be modified accordingly.

The Insurance Industry’s Response

The effects of climate change continue to prompt global temperature rise, ocean warming, and the resultant rogue’s gallery of weather disasters. As a result, insurers are seeing the total dollar amounts of insurance coverage for commercial properties grow more significantly than they typically do in response to gradual population rise and economic changes.

This disparity is getting out of hand. In response to the staggering increases of insured losses, many insurers raise premium rates and, in extreme cases, withdraw from afflicted markets altogether, prompting unfavorable economic consequences. But the impact of climate change on the insurance industry extends beyond traditional risk assessment – it transcends across all property and casualty lines of business.

When analyzing and evaluating insured losses within property insurance, for example, natural disasters fall into one of two categories: intensive risk – low frequency and high severity events such as hurricanes, cyclones, and earthquakes; and the inverse i.e. high frequency and low severity risks like flash floods, wildfires, and prolonged heatwaves. As an example, in liability insurance, temperature swings and weather extremes expedite the degradation of transportation infrastructure, which inevitably lead to a surge in accidents and insurance claims.

Insurers are seeing the underwriting on the wall. In a survey conducted by financial intelligence firm, Moody’s Analytics, targeting 30 global insurers across North America, Europe, Asia, and Australia, 52% foresee current risk assessment tools receiving substantial alterations to account for climate-induced incidents. Although 14% of these firms intend to rely on their current risk management capacities, 34% plan to create new climate-related risk models altogether.

Given the trajectory of climate change, this figure should be higher.

The Role of Reinsurance

In recent years, reinsurance has emerged as a financial saving grace for insurers in the wake of the climate change disasters. Reinsurers – those who provide insurance for insurers – wind up bearing a substantial share of the insured losses resulting from such events. However, this often results in raising reinsurance premiums, which snowball into issues for the insurance market, and eventually, the public.

Reinsurers therefore need to mitigate their own vulnerabilities to climate risks by exercising proper exposure management practices and ensuring that the insurers are doing the same. Reinsurers will also need to explore capital market solutions and alternative risk transfer mechanisms to address the increased exposure of property catastrophe losses. The intensifying nature of hurricanes alone should be enough to compel reinsurers to develop new models and pricing strategies to cover this recurrent risk.

There is also a pressing need for reinsurers to enhance their risk modeling procedures, especially when it comes to extensive climate risks. In fact, these types of weather events account for 42% of total economic losses in low-middle income countries – a pattern that is dangerously trending upward and thus demands accurate real-time risk assessment.

Weathering the Storm

Many of the storms and weather events occurring around the world today have truly entered a new realm of severity. Beyond the tragedies that climate change has imparted thus far, the crisis is forcing the landscape of the insurance industry to adapt.

Insurance coverage is a lifeline, but the scale of these weather extremes are forcing insurers to place even greater reliance on reinsurers for accurate risk and capital management. Considering the alarming outlook for the environment, reinsurers must remained focused on ensuring the proper risk assessment and pricing in order to effectively weather the storm.

Martin Greenberg is the head of Reinsurance Business Practice, Sapiens

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