How can insurers respond to rise in natural catastrophes?

June marks the beginning of the US Atlantic hurricane season, which runs until the end of November. This year, the National Oceanic and Atmospheric Administration (NOAA) is predicting above-normal hurricane activity, raising the spectre of devastating destruction and loss of life. NOAA is forecasting 14-21 named storms, of which 6-10 could become hurricanes. NOAA is also predicting as many as six major hurricanes, where winds will exceed 110mph.

But this year should not be considered an anomaly. The ongoing effects of climate change will lead to more freak weather patterns, presenting enormous challenges both to property owners and to insurers. Natural catastrophes like these (or ‘nat cats’) have the potential to wreak massive losses on insurance companies and bring fresh turmoil to an industry where uncertainty is despised.

Erdem Karaca, Head of Cat Perils Americas for Swiss Re, outlines the scale of the problem: “Natural catastrophes in North America caused approximately US$80bn of total insured losses last year. The losses incurred in 2020 were only slightly lower. More than half of the loss experienced in 2021 was caused by two events: Hurricane Ida and winter storm Uri.

“The former was the most significant nat cat event globally with more than $30bn total insured loss. While a majority of the losses were from wind and storm surge damage experienced in Louisiana, where it made landfall, Hurricane Ida also led to record rainfall and significant flood losses in the Northeast. Winter storm Uri, which resulted in freezing and major power outages in Texas, caused $15bn insured loss and became the largest winter storm loss in history.”

Global inflation could compound insured losses

In its latest nat cat report, the reinsurance firm indicated a long-term trend of 5-7% growth in insured losses, underlining the growing problem that insurers face. This growth reflects both increased frequency and severity of nat cat events (especially in secondary perils, such as severe convective storms and wildfires) as well as changes in exposure due to economic growth, population growth and urbanisation.

Karaca continues: “Nat cat losses have been trending upward beyond global inflation or economic growth by a combination of factors, including potential impact from climate change on perils such as wildfire as well as exposure growth in nat cat exposed areas like coastal cities or other flood-exposed areas. As such, we can expect a continuation of the same trend in the long term.

“In fact, a repeat of events experienced in recent years, like the 2017 Hurricanes or California wildfires, can lead to significantly higher insured losses as a result of the significant increase observed in material and labour costs in the last couple of months.”

What can insurers do to adapt to climate change?

Matt Junge, Head of Property Underwriting R&N US for Swiss Re, explains what insurance companies need to do to adapt to the threat posed by climate change: “Short term, insurers need to not ignore emerging loss trends. We see many examples of insurers waiting more than five years to recognise increased frequency or severity is a trend that needs to be addressed.

“While we're not advocating for the industry to overreact to cat losses that are within expectations, our industry cannot adequately address increased losses from climate, inflation or social factors to name just a few factors that we've seen have a significant impact on property claims in just the last couple years.

“Longer term, I'd love to see our industry focus much more on loss mitigation and influencing stakeholder actions that reduce loss, rather than just focus on addressing the trend through pricing. Price is important, but addressing climate trends requires more than just an appropriate rate.”

Will climate change make insurance premiums more expensive?

As climate change makes freak weather events more common, the inevitable question that consumers ask is whether their insurance premiums are destined to go up. If the frequency and severity of nat cats is rising, surely consumers will have to pay more to secure adequate coverage? Coupled with a rising cost of living, this is a burden that many of the most vulnerable consumers simply cannot bear.

Rising insurance premiums are not necessarily an unavoidable consequence of climate change, Junge explains, particularly if insurers take the right steps. “Coverages can be adjusted and new products, like parametric insurance solutions, can address coverage gaps in an affordable way,” he tells us. “Couple this with an increased focus on mitigating losses, for example through a programme like the IBHS Fortified Homes programme, and it is realistic to think that premiums do not need to be ever-increasing.”

The programme that he refers to is a construction standard nationally recognised across the US that ensures homes are better able to withstand severe weather events like hurricanes, thunderstorms and low-level tornadoes. The Insurance Institute for Business & Home Safety (IBHS), which administers it, says that the Fortified Homes scheme is based on 20 years of scientific research and real-world testing. Insurers sometimes offer discounts on premiums to customers with homes that adhere to the standard, incentivising them to reduce their exposure to risk before an event happens.

Are wildfires and cyber threats the new ‘uninsurables’?

Flood was long considered an uninsurable risk, with an inability to effectively model, underwrite and price it leaving insurers reluctant to provide coverage. As technology evolves and our understanding of flood risk becomes more sophisticated, that situation is rapidly changing. In much the same way, there are other areas of insurance risk today where we can dramatically improve.

“Cyber and wildfire have some parallels,” Matt Junge says. “To be insurable, our industry needs to be able to evaluate the risk and then determine an appropriate price. Improvements in flood hazard mapping, coupled with increased computing power, have led us to be able to understand and price flood risk for an individual home. Cyber is a complex coverage with systemic global risk and we're in a relative infancy in understanding the coverage. You could say the same about wildfire. Most companies that have a presence in California are adept at using the latest technology to evaluate and price individual home wildfire risk, but we know wildfire extends beyond that state's borders and many more companies need to recognize the potential severity of that peril.”

As freak weather patterns become more common, vulnerable communities will wonder whether the increased frequency and severity of weather events will make affordable insurance unobtainable for them. There is no simple answer, Junge explains, but if insurers work together, nobody needs to be left in the lurch.

“Markets like Florida remind us that confluences of multiple factors can create serious challenges in any insurance market. Insurers have been quite creative in adapting to the ever-changing impact of nat cat events, while still providing coverage to their policyholders. We continue to see new insurers enter segments other insurers have left. No doubt, residual markets will remain important mechanisms to covering catastrophe risk, but if the key stakeholders in loss mitigation can work together with a long term vision, even high-risk areas will continue to be insured.”