18 September, 2007
“The cost of insured losses will rise significantly in the next decade due to an increase in the number and severity of weather-related natural catastrophes as a result of climate change”, said Mr Clement B. Booth, Member of the Board of Management of Allianz SE, releasing the report, Hedging Climate Change.
The number of natural catastrophes has been trending strongly upwards over the last four decades, from an average of around 30 to 40 per year in the 1970s to an average of around 120 to 140 per year since the early 1990s. And the vast majority of these are weather-related, suggesting a connection between increases in natural catastrophes and rising global temperatures as a result of climate change.
At the same time, insured damage from natural catastrophes are also trending upwards. Average insured damage from natural catastrophes was less than $US5 billion per annum between 1970 and 1989. Since then, insured losses have increased significantly, averaging around $US18 billion per annum during the 1990s and $US30 billion per annum between 2000 and 2006.
Mr Booth said, “Allianz has analysed the trends in the number of natural catastrophes and the resulting insured losses, including taking into account other developments such as increasing urbanisation, as well as coastal and floodplain development. From this analysis, it is projected that average insured damages from natural catastrophes could rise to a projected $US41 billion per annum over the period 2010 to 2019.”
Clement B. Booth, “Insured losses will continue
to rise due to climate change”
Using conservative total loss to insured loss ratios of 2:1 and 3:1, projected total damages from natural catastrophes could average between $US80 billion and $US120 billion per annum between 2010 and 2019. However, these are only averages, and past experience suggests that losses in any particular year can reach three times trend average and have reached nearly four times trend on one occasion.
“On this basis, annual total losses of up to $US400 billion as a result of natural catastrophes are not only possible but probable,” Mr Booth added.
Research indicates that the efficiency of catastrophe risk markets is not high:
- a large proportion of catastrophe risks are not insured;
- diversification of catastrophe risk is not optimal;
- catastrophe risk premiums for both insurance and reinsurance are very expensive in some markets – sometimes seven times expected losses; and
- demand for catastrophe risk insurance is occurrence dependent. Premiums rise sharply after large events (and demand falls).
According to Mr Booth, “insured damages from natural catastrophes at projected future levels will put pressure on catastrophe risk markets, which already operate at sub-optimal levels. In these circumstances, the insurance industry needs to continue to develop alternative approaches to risk transfer, such as catastrophe bonds and risk partnerships between insurers and governments.”
Capital markets have an increasingly important role to play in the diversification of natural catastrophe risks. This is because damage levels are relatively small compared to market capitalisation. For example, the value of the average fluctuation of all the net assets traded daily in the US alone amounts to $US133 billion. Against this background, larger insurers (and investment banks) have developed a number of capital market instruments, in particular, Catastrophe Bonds.
The number and volume of Catastrophe Bond issuances has increased in recent years. Issuances in the first half of 2007 have already surpassed the total for 2006, which itself was more than double that of 2005.
“In early 2007, Allianz launched a $US157 million bond with a maturity period of six years to hedge against floods in the UK and earthquakes in Canada and the US (except California). These risks were chosen because they are high risks that are insufficiently covered by existing reinsurance. The market response was positive and the bond was several times oversubscribed,” Mr Booth said.
According to Mr Booth, “another alternative approach is the development of risk partnerships between private insurers and governments, which can exert considerable influence over the effects of natural catastrophes.”
Examples of such partnerships include:
- flood risk in the UK; and
- government reinsurance.
“The flood insurance arrangements in the UK are one example of an insurergovernment risk partnership. However, a large range of cooperation possibilities existin areas such as safety standards, land-use planning, construction regulations, public infrastructure, catastrophe protection measures and taxation arrangements,” said Mr Booth.
In relation to State reinsurance, Mr Booth noted, “when reinsurance cover is limited and capital market instruments are under-developed, the insurability of natural catastrophes can be improved through government reinsurance. Such arrangements have been put in place in a number of countries, including Australia, in respect of terrorism cover in the aftermath of the September 11 attack on the World Trade Centre.”
Government reinsurance programs should be based on the following principles:
- They should only be available for major damage above a certain level, which would depend on market conditions, out of which would emerge a system of multi-layered liability, as is typical in insurance markets.
- Private insurance should always remain involved to retain flexibility, for example, a proportional division of coverage – above a certain level – between insurers and the government.
- Premiums should be set at levels appropriate to the risk. Premiums that are too low will crowd private insurers and reinsurers out of the market and increase moral hazard behaviour.
Concluding, Mr Booth said, “climate change is clearly one of the greatest challenges facing not only insurers, but the whole of humanity.”
“Allianz is taking a leadership position on the issue of climate change on a range of levels. In relation to the issues raised by Allianz’s Hedging Climate Change report, we will continue to look for new and innovative approaches to the challenge of risk diversification in the face of increasing levels of damage from weather-related natural catastrophes.”
“Allianz’s objective is to maintain and even extend the scope of insurance coverage
against natural catastrophes so we can continue to provide comprehensive insurance solutions to our customers.”
Allianz Australia offers a wide range of insurance products and services including car insurance
, home insurance
and Life insurance