Niklaus Hilti, Head of Credit Suisse Insurance Linked Strategies,
Georges Bolli, Risk Aggregation & Management at Credit Suisse Insurance Linked Strategies
We took those findings that concern climate trends and tried to quantify their impact on the overall insurance industry, which includes the reinsurance and ILS markets. We believe that this report is the first of its kind to quantify the annual inflation of insurance losses due to climate change for the reinsurance and ILS markets. We also attempted to quantify the expected effects of a warmer climate that further increases extreme weather events on the (re)insurance industry over the next 20 years.
We believe that the annual inflation of losses for the (re)insurance industry due to climate change on property insurance lines is around 1.35% to 2.50%, depending on the exposure, region, type of natural peril, and seniority of the reinsurance transaction. The (re)insurance industry (including ILS) has not increased premiums sufficiently over the last two decades. In particular, the lower reinsurance premiums during the soft market phase between 2013 and 2017 were a heavy burden for margin adequacy. However, the challenging years from 2017 to 2021, with significant natural catastrophe losses, led to a steady increase in premiums on an almost global basis. This positive momentum was and still is necessary to adapt risk-adjusted premiums for reinsurers and ILS investors. Furthermore, the reinsurance market (including ILS) cannot afford to have lower risk-adjusted premiums going forward. Considering the inflation of insurance losses, risk-adjusted premiums will have to increase on average by at least 2% every year just to remain risk neutral (from a climate change perspective) in the future.
One of the questions asked most frequently by investors these days is whether risk models adequately reflect the climate change trend. We conducted an analysis of US hurricane risk, covering the period between 2006 and 2021. Our analysis showed that the inflation of insurance losses due to climate change is captured by the vendor model we included in our assessment.
Ultimately, we are convinced that it will be essential to apply strict measures and take decisive steps in managing the risks within ILS portfolios to make them resilient to inflation of insured losses caused by climate change. We believe that a combination of de-risking and higher premium levels is key for the reinsurance and ILS markets. Furthermore, the reinsurance and ILS markets have to react decisively now and demand annual increases in risk-adjusted premium levels in order to at least remain risk neutral with regard to climate change.
The IPCC is an independent body that comprehensively analyzes and summarizes current research on climate change. The IPCC’s Sixth Assessment Report, which was published in August 2021, included explicit assessments of extreme weather events around the world in a changing climate for the first time, including on a regional scale. In this latest report, the IPCC published its findings on the causal relationship between human-induced global warming and extreme weather events, such as droughts, extreme precipitation, tropical cyclones, and other storms. It is clear from the report that even relatively small incremental increases in global temperatures can result in disproportionate changes in extreme weather events.
In this report and the underlying analysis, we attempt to apply the latest findings in the IPCC report to the (re)insurance and ILS industry, to answer the following questions:
- What are the most important extreme weather events for (re)insurance and ILS and what are the climate change trends observed for these risks?
- Do the risk models used in the (re)insurance and ILS industry correctly reflect those trends?
- Are market participants pricing climate change into their products?
- Are (re)insurers and ILS investors adequately compensated for climate trend risks?
- Are there ways to manage climate trends in (re)insurance and ILS?
- What is the outlook for the industry and how will the already inevitable further temperature increases impact the profitability of the global (re)insurance and ILS industry?
What proportion of the reinsurance and ILS markets is exposed to climate change risk?
Chart 1 shows the exposure to different regions and perils in the cat bond and reinsurance markets. Perils in gray indicate exposures that are not weather related. Those in green indicate exposures that are weather related. Perils in blue indicate mixed exposures, which may be weather related. In our impact analysis regarding climate change trends, we included green and blue perils. Therefore, our analysis covers approximately 80% to 90% of the weather-exposed part of the cat bond market and approximately 70% to 80% of the weather-related or weather-exposed part of the property catastrophe reinsurance market.