RMS: modelling in an uncertain climate

It’s never certain exactly what will come up at Baden-Baden, but ahead of this year, it’s already clear climate change will be one of the big topics.

It is, as Laurent Marescot, senior director at RMS, told Intelligent Insurer’s 1.1 Club, the online hub for one-on-one discussions with industry leaders, “top of many discussions” now happening in the industry. It’s posing a big question for insurers, but also for modellers such as RMS—or rather, two questions.

“One is how much the climate change so far is included in the models today. How much are the past human impacts on the long-term climate reflected in the model when they use it to price the risk for the next couple of years?” Marescot said.

The answer to this is “completely”. On the other hand, if the question is how much of the current events are down to manmade climate change, the answer is “it’s impossible to say”.

“It’s vital to understand that the models as they are built include the signal of what has happened over the past 40 years or 50 years,” he explained. “But we are not looking at detrending the climate change signal from that. It’s not something we can do.”

It must attempt something slightly similar to answer the second question, however. While the industry’s immediate focus has been the first issue, which relates directly to the business it writes on an annual basis, re/insurers are increasingly looking further ahead.

“Many players in this industry are now starting to ask questions about the more long-term climate change,” said Marescot. “It’s particularly key if you’re in property lines of business, infrastructure or manufacturing.”

In response to that, RMS’s new probabilistic models launched earlier this year allow insurers to model the future impact of climate change according to different scenarios mapped out by the UN Intergovernmental Panel on Climate Change and across different time horizons.

“They can use the 2020/2030 perspective for portfolio management and the 50 or 100-year outlook to respond to regulatory stress tests, for example,” he explained.

Playing its part

Another hot topic at Baden-Baden is likely to be the flooding in Germany and Belgium. Again, it’s a closely related issue. Marescot said: “While it’s difficult to link any individual event to climate change, there’s consensus on the overall trend.

“It’s clear that the risk of flooding is increasing in Europe because the risk of heavy precipitation is increasing,” he added.

There are again consequences for modelling—not least because the summer 2021 flooding had two elements.

“In most parts of Germany and other places in Europe, we had record-breaking precipitation. In many places, there was between 100 and 150mm of water in 24 hours, it was record-breaking,” he explained. “That’s the first element.

“The second is the fact that the soil was extremely saturated, so it couldn’t absorb any more water.” This is what led to the large peak flows in small river systems and the consequent damage, he concluded.

“It’s important to understand that if you want to be able to model that risk, you need to use a model that reflects these features. That’s not achieved if you use very basic modelling solutions.”

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Improvements in modelling will not just leave re/insurers better prepared for the next event; they could also reduce its impacts.

Re/insurers have a significant role to play in building greater resilience across Europe and elsewhere. In part, that will be achieved by addressing the protection gap in flood risk exposed by the recent events. But insurers are also increasingly recognising their role in mitigation.

“We are moving towards a concept of total resilience,” said Marescot. Insurers’ contribution to financial resilience is already well accepted, but they also have a role in physical resilience, and again this will be helped by modelling.

Marescot pointed out that with RMS’s model, for example, users can adjust flood defences to see the impact on losses. That can enable insurers and insureds to evaluate the cost and benefits of greater investment.

“A key element we have seen is that the insurance industry is moving to a more active role,” he concluded. “They can provide information and motivation for mitigation, not just be there to absorb the residual risk.”

To view the full 1.1 Club session click here