25 November 2016 Insurance

Correlations between perils not substantial enough to warrant capital changes

The majority of perils are not substantially correlated enough to warrant changes to the amount of capital held to cover extreme weather claims, according to a study from Lloyd’s.

The report built upon Met Office research and the links between extreme weather events occurring in separate regions of the world that can take place over a range of timescales from days to years, known as teleconnections.

The report found that extreme weather events are not linked by teleconnections and can therefore be considered independent by global reinsurers when asserting many of their key aggregate risks around the world.

Although the majority of perils were found not be significantly correlated, the Met Office did identify nine noteworthy peril-to-peril teleconnections, most of which are negatively correlated.

Lloyd’s suggested that even when there is some correlation between weather patterns, it does not necessarily follow that there will be large insurance losses.

Extreme events may still occur simultaneously even if there is no link between them, and an assumption of independence for capital-holding purposes is therefore appropriate for the key risks the Lloyd’s market currently insures, the report said.

Trevor Maynard, head of exposure management and reinsurance at Lloyd’s, said: “The report’s findings go a long way to answering the challenge that capital for local risks should be held in their own jurisdictions.

“Lloyd’s believes this approach reduces the capital efficiency of the re/insurance market by overlooking the heart of insurance and the diversification benefits provided by writing different risks in different locations, and in doing so, needlessly increase costs to the ultimate detriment of policyholders. Insisting on the fragmentation of capital is not in the best interest of policyholders.”

Dame Julia Slingo, chief scientist at the Met office, added: “This report demonstrates the continuous improvement in our understanding of connections between climate drivers and regional perils across the globe.

“When we add this to our cutting-edge capabilities in simulating the global climate to the local weather and in deploying these for more skilful long-range predictions, we can help re/insurers model multiple, and possibly teleconnected, scenarios and more effectively manage their portfolio of risk.”

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