November 20th, 2013

Responding to Climate Change: Part I

Posted at 1:00 AM ET

Although there has been a significant increase in both economic and insured losses from natural catastrophes in recent decades, it is important to put these numbers in context. With the exception of coastal flood, inland flood and drought, the wholesale attribution of rising financial losses to an increase in hazard frequency can be misleading. Statements concerning the influence of global warming on loss trends would be better served if normalized by factors such as inflation, (per capita) gross domestic product, total insured value, population density and annualized property value. Indeed, the IPCC agrees that ignoring these factors leaves an upward trend in losses for purely economic reasons, notwithstanding any behavior in the peril. As an example, the recent “trend” in hurricane losses for the coastal United States loses clarity when normalized by inflation and population density. (1)

However, given the IPCC’s conclusions on flood, drought and changing weather patterns, and some evidence of such change over the last 50 years, it is vital that (re)insurers consider how the changing climate could impact future losses. Global warming potentially poses a serious financial threat to (re)insurers, with implications on catastrophe risk perception, pricing and modeling assumptions.

Recent events such as the Thailand floods have also demonstrated how physically unaffected businesses on the other side of the globe can be affected by supply chain disruption. Such scenarios could lead to an unforeseen accumulation of losses and have resulted in many carriers reassessing their BI and CBI coverage. (2)

Understanding how future claim levels and trends may change is therefore essential to ensuring that adequate cover is being offered and premiums are priced at the right level. The coastal flood threat is particularly acute under global warming and emphasizes the need for a flood insurance strategy that is actuarially sound and accounts for the various regional, physical, economic and political constraints affecting the flood problem.

Notes:

1. Pielke et al., 2008
2. Thailand is a major hub for auto and hard disk drive manufacturing, and the floods forced the closure of hundreds of factories in large industrial parks. This led to a shortage of parts and interrupted production around the world.

Link to Part II>>

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