 By Graham Hall, Associate Consultant and Dom Del Re, Associate Director, PwC Catastrophe Risk Management
Social and climate changes will alter the exposure profile and sources of claims that insurers face, and insurability of risks will increasingly become a critical question for governments, businesses and individuals. The industry faces many issues and the actuarial and modelling community will be required to work towards accessible solutions, globally as well as closer to home.
In the context of a changing climate, uncertainty around the frequency and severity of weather systems is increasing. When adjusted for inflation, the paid claims on weather related catastrophes have doubled every decade since the 1980s.
In his December 2012 article in Science magazine, Intergovernmental Panel on Climate Change (IPCC) member Evan Mills lays out a key role of the insurance industry in responding to the challenges of climate change: many risks will become uninsurable unless climate change mitigation measures progress significantly, or insurance companies become more effective at advancing and adapting their current models to incorporate the effects of our changing weather systems. Although to date several innovations, such as microinsurance, have been developed to benefit policyholders, these schemes remain few and far between, and coordinated international government engagement in developing solutions remains low.
In May 2013, the UN published its Global Assessment of Risk (GAR13) report warning that direct losses from floods, earthquakes and drought were under-estimated by at least 50%, and with economic losses “out of control”, businesses need to act to protect themselves better.
However, purely focusing on climate change and frequency of natural catastrophes would result in us failing to consider several other factors which are significant in changing the global risk profile, such as the increasing premium gap and the chronic issue of underinsurance. The effect is particularly pronounced in developing countries where insurance penetration is low, resulting in a lack of catastrophe modelling expertise in these areas due to an absence of commercial demand.
With significant growth in the global middle class expected over the next 30 years and a simultaneous shift in the distribution of wealth, demand for catastrophe insurance will increase significantly in areas where risks are currently poorly understood. Latest estimates from the OECD Development Centre suggest that 58% of the international middle class will live in the Asia Pacific region by 2020, up from 28% today. Over the same time scale insurance premiums in the region are expected to double.
The effect of urbanisation is a further complication resulting in higher concentrations of economic risk in potentially catastrophe exposed regions. The humanitarian and financial effects of catastrophes in urban areas are well documented, but the level of understanding of urban catastrophe risks is often markedly lower. According to the UN, by 2050 approximately two thirds of the world’s population is expected to live in urban areas, increasing from 50% today.
A new report by the UN International Strategy for Disaster Reduction (UNISDR) and PwC (www.pwc.com/resilience) warns that large multinationals’ dependencies on international supply chains, infrastructure and markets poses a systemic risk to ‘business as usual’, as mounting losses this century from catastrophic events top $2.5 trillion.
Looking at a specific example, the 2011 catastrophe in Thailand demonstrated that exposure accumulation creep and the unanticipated severity of the event led to large unexpected losses. Flood cover is now increasingly difficult to obtain in the region as insurers struggle to understand their actual level of exposure, and the Thai government has been forced to intervene by establishing a catastrophe insurance pool, the National Catastrophe Insurance Fund.
According to the Environrnent Agency, even in the UK, nearly 1 in 6 people now live or work in properties that are at risk of flooding from rivers or the sea. The floods in June 2007 were the third most expensive global flood event ever, with total insured losses of £3billion, and lead to increased premiums and excesses across the market. The end of the Statement of Principles in July 2013 has raised further questions around the insurability of UK flood risk, with up to 200,000 homes situated in high risk areas where they might be unable to renew their coverage against floods. Research from Air Worldwide has shown that climate change will result in additional complications; if the temperature in the UK increased by 2°C the average annual industry loss from flooding has been estimated to increase by up to 8% from today’s figure. It is therefore important that models currently used by the insurance industry for solvency capital calculation purposes can be adapted to help the UK Government and ABI reach a mutually satisfactory long term solution, rather than a series of potentially destabilising short term agreements.
The actuarial profession has an essential role to play in interpreting the results of the currently available loss models, and to collaborate with the climate and loss modelling community to develop the models for the future. Actuaries are accountable for assisting markets and governments to find the technical solutions to manage the dynamic effects of an increasingly unpredictable global climate. This responsibility falls equally on the shoulders of modelling, pricing and product development actuaries.
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