A recent Allianz report calls for new approaches to risk diversification in the insurance industry to prepare for climate change-related damages. The questions is how to insure catastrophes caused by climate change.
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Hedging Climate Change(click on the image to download the study) |
Each time the UN comes out with a scientific assessment of climate change, its findings are more certain and alarming. Warming global temperatures will bring more frequent heat waves, longer droughts, and more intense storms. While certainly troubling, these trends come as no surprise to insurance companies that have been tracking the rising costs of natural disasters for decades.
According to the "Hedging Climate Change" report published by Allianz SE, the number of natural catastrophes has been on the rise since the 1970s. Subsequently, the report's central concerns is how to ensure the rising number of climate change-related catastrophes.
Highly under- insured
History's biggest individual case of financial loss, Hurricane Katrina, caused 144 billion dollars in total losses in the southern United States - only 49 billion of which were insured. The study finds that this lack of coverage is directly related to the specific characteristics of natural catastrophes. Being low-frequency - high severity risks, natural disasters undermine the basic principle of insurance: pooling individuals with limited but unconnected risks.
Under text-book conditions, an insurer can assume that, in any given period, premium income will be sufficient to cover insured losses. But damages caused by natural catastrophes vary greatly in magnitude and their likelihood is hard to predict. This makes the traditional calculation of premiums extremely difficult.
So what?
Innovative developments by insurers can help improve the insurability of catastrophes. So-called catastrophe bonds (cat bonds) enable risks to be transferred to capital markets. Allianz has launched two cat bonds, one to transfer the risks of severe floods in Britain and earthquakes in North America, and the other to transfer risks of windstorms in Europe.
Sharing risks among private and public partners is another strategy to provide insurance for catastrophes. Public-Private-Partnerships can be especially successful if backed by public policies such as restrictions on the construction of new buildings in vulnerable regions. Partnerships can also help to make unavoidable effects of climate manageable for society.
