Despite increased efforts to incorporate climate change in their decision-making process, reinsurers could be downplaying their exposure to natural catastrophe risks between 33% and 50%, a new study by S&P Global Ratings has found.
Results of the financial services giant’s recent stress test suggested a US$150 billion insured industry loss at a one-in-10-year return period, which was a greater frequency than the one-in-20 and one-in-30-years that many of the world’s largest reinsurance companies were estimating the size of their loss from.
According to the report, this scenario pointed to a material increase in the amount of capital reinsurers and insurers would need for their catastrophe exposures – which was a one-in-250 catastrophe charge based on S&P’s risk-based capital model – to the tune of US$21.7 billion aggregate for the industry. This would increase the modelled exposure to a one-in-10-year event by at least US$7.4 billion in aggregate.
“Unmodelled risks and the inherent difficulties in attributing extreme events to climate change create the risk that climate change may not be fully reflected in catastrophe modelling, particularly in the short term,” wrote Dennis Sugrue, global environment, social, and governance (ESG) lead for insurance ratings, in his analysis.
The study also found that 71% of reinsurers considered climate change in their pricing assumptions, but only about half of these firms included a “specific component of the price allocated to climate change.” The report added that the amount ranges between 0% and 10% of the rate charged and did not appear to be a significant factor in market pricing.
The insurance sector could be facing a costly year of natural catastrophes, which reinsurers attributed to extreme weather caused by climate change. If this happens, Sugrue wrote that there would be a “significant potential for volatility in earnings and capital” that could wipe out “91% of the sector’s buffer above the ‘AA’ capital requirement.”
However, Sugrue noted that these results were not “intended to affect ratings or change our base-case assumptions for our analysis of the ratings on reinsurers.” He added that the agency felt that the “scenario could help reinsurers to have an even greater focus on the short-term impact of climate change.”
“We believe that those companies that take a more proactive approach to understanding and adapting their exposure to climate risk will be better protected against future capital and earnings volatility linked to climate-related losses,” Sugrue wrote.