21 October 2014 Insurance

Changing weather prompts new structures

Insurers should re-examine the suitability of their reinsurance programmes in light of evidence that weather risks are changing and causing more frequent small- to medium-sized losses in many markets, executives from Munich Re said in Baden-Baden yesterday.

Ludger Arnoldussen, member of the board of management of Munich Re, said that such a pattern of losses on a regular basis, very few of which would penetrate the excess-of-loss layers of many insurers’ reinsurance programmes, should prompt cedants to reconsider the way they structure their programmes.

“In the past decade, we have seen cedants shift their reinsurance programmes from buying more proportional covers towards buying more non-proportional excess-of-loss type structures, especially on the catastrophe side. That is designed to cover very large losses—in Europe these are generally winter windstorm events. But it does not adequately protect their earnings against these types of regular mid-scale events.”

Peter Höppe, head of Munich Re’s Geo Risks Research/Corporate Climate Centre, noted that in 2013, for example, a number of events across Europe resulted in medium-sized insured losses. These included heavy flooding in Germany, the Czech Republic and Austria, which caused insured losses of €2.4 billion (the world’s most costly loss that year); flooding in the UK resulting in losses of €1.1 billion; and hailstorms in Germany, which resulted in losses of €2.8 billion.

The losses are exacerbated by recent changes in the design of homes in some parts of Europe. The growing use of thermal insulation and solar installations, for example, tend to aggravate claims volatility.

But Arnoldussen stressed that few such events would penetrate most insurers’ excess-of-loss programmes, resulting in more volatility in the underlying results of these companies. He said that they should consider restructuring their programmes to include some kind of protection on the basis of accumulated losses.

“We think adequate risk protection products can be designed to deal with these more localised events and to fit with their goals around the volatility of earnings,” Arnoldussen said. “We want to be at the edge of innovation in this regard. We offer such products and we are also investing heavily in the development of other solutions such as weather derivatives.”

Höppe said that the problem is being driven by a greater frequency of persistent weather patterns in Europe, involving long periods of dry weather or precipitation that may lead to droughts or flooding. This means the number of loss occurrences resulting from severe weather events is on the rise. He also stressed that in addition to causing direct losses, this may cause companies whose income is weather-dependent to sustain a loss in earnings.

“This is a phenomenon backed by a number of scientific studies—it means you will have persistent weather of a certain type in one location for several weeks.

“It could be a heat wave or, in other areas, it might result in floods or thunderstorms. But we are seeing more extremes and this has implications for the way the industry must respond to this risk,” Höppe said.

He said the industry should be prepared for more extreme weather. He also noted that, in terms of higher levels of precipitation, this was partly being caused by global warming.

“You have warming sea surfaces around the world and this leads to more water in the air. In turn, this eventually fuels thunderstorms. We are seeing a shift in the weather machine,” he said.

Arnoldussen added that another factor the re/insurance industry should consider was the overall effect weather events can have on the wider economy. He said estimates suggest that some $5.7 trillion of US GDP is what he called “weather-sensitive”. This translates into a typical annual variance in US GDP due to the weather of 3.4 percent—$485 billion.

He said Munich Re was actively developing solutions to this problem. A year ago, the German reinsurer boosted its capabilities in this field with the acquisition of RenRe Energy Advisers, a weather risk trading company, which it has merged into its own capabilities.

“We can now provide an even more comprehensive service—a one-stop client-centric unit able to provide solutions to these problems using an array of risk transfer instruments,” he said.

“We anticipate increased demand for these products and we think it is an area where we can enlarge and push the boundaries of insurability—which is one way of addressing the competitive landscape we are facing in other areas.”

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