Climate Change: An Important Challenge for Insurers and Reinsurers

By Jérôme Boucher

An interesting aspect of the actuarial profession is that it is always evolving. It has to adapt its methods to the changes that occur in the society and the environment. Over the last decade, many studies have been made to determine the effects of climate change on the environment. Many of them showed that it is very likely that the temperatures will rise and many endangered animal species might disappear. For property and casualty insurers, climate change represents an important challenge because the rising seas, the increased risk of drought, fire and floods, and the stronger storms that may occur will have a huge impact on the claims of the people insured.

Many disasters occurred recently and had huge financial impacts. As a matter of fact, 2011 was the costliest disaster year ever in the world. In 2011, $380 billion global economic losses have been caused by natural disasters. Most of the economic losses that year were due to the magnitude 9.0 Japan earthquake and tsunami, the costliest natural disaster in history. During that year, a significant earthquake also occurred in Christchurch, New Zealand, and the hurricane season in the United States was costly, too. For example, hurricane Irene caused more than $15 billion in damage1 .

Here are some statistics. According to the Insurance Australia Group, a 1°C mean summer temperature increase will increase the risk of bushfires by 17 to 28 percent. Furthermore, a 25 percent increase of the quantity of rain received during a 30-minute precipitation might imply that a huge flood that is normally seen once every 100 years becomes a flood that might occur once every 17 years. As you can see, small changes in climate statistics can dramatically increase hazards.

With the rising costs of the damages caused by natural disasters and the higher frequency of catastrophes, people want to find ways to hedge their risk and not have to assume all by themselves the significant financial losses that might occur. That’s why people tend to subscribe more and more insurance against natural disasters. To keep premiums affordable, insurers must keep premiums low and ensure the long-term insurability of climate risks, and their clients must find ways to reduce their risk.

The population has many ways available ways to reduce its risks. One of the most efficient is prevention. A study published by Swiss Re in 2010 showed that between 40 and 68 percent of all annual losses resulting from natural disasters could have been avoided by cost-effective prevention measures. For example, in a region where hurricanes represent a big risk, the construction of dikes, a better use of the vegetation, and changes in the construction norms could significantly reduce the damages caused by hurricanes each year. It would therefore be very important for governments and insurers to encourage prevention.

Funds are also created to give financial support to the devastated population. For example, the Caribbean Catastrophe Risk Insurance Facility was created in 2007 and offers financial support to the governments of 16 countries of the Caribbean against the risk of hurricane or earthquake. The population gets access to the indemnities much faster. The amount given in indemnities depends on the severity of the events rather than on the individual claim process.

Reinsurance is also a good way to help insurers reduce their risk: they are not the only ones assuming the potential financial losses of a client.

To summarize, for the population, prevention and financial planning are excellent ways to help keep the insurance policy at affordable rates because the insurers will ask a smaller premium if some risks are reduced or eliminated. On the other hand, insurance helps limit the financial losses resulting from a catastrophe.

Many solutions already exist but insurers will have to continue their research to find ways to efficiently insure the populations against catastrophes. It is very important that they see it as an opportunity rather than a problem. Because, after all, risk is opportunity!

Footnote

1 http://www.ouramazingplanet.com/2219-2011-expensive-natural-disaster-year.html

Jérôme Boucher is a student at Université Laval.

Summer 2012