Insurers can no longer avoid climate change: industry pioneer

“External stakeholders are requiring that insurers are explicit about how they’re dealing with climate change. It behoves the modelling companies to bring clarity to the loss potential from perils, in a way that not just scientists but CEOs can understand it,” says Karen Clark, founder of catastrophe risk management firm  Karen Clark & Company (KCC).

Speaking  in the Re/insurance Lounge, Intelligent Insurer’s digital hub for interviews, debates and panel discussions, the industry pioneer explained it is now vitally important that insurers and modelling companies not only account for climate change but do so in a very clear way, so that boards know exactly how this is being built into the models.

At KCC, the idea of climate change is split into two parts. First, the models build in what has happened to date (including wildfires over the past decade and hurricanes over the last 30 years). Clark believes this captures all the impact of the climate to date and works as a reference point.

Second, KCC uses projections from the Intergovernmental Panel on Climate Change (IPCC), taking the different scenarios of best case, worst case and middle of the road for each climate scenario.

While the IPCC’s projections extend to 2100, KCC decided to project to 2025, 2030 and 2050, following conversations with clients. Now, the firm has nine different climate scenarios for three perils: hurricane, wildfire and winter storms.

Clark adds: “We believe that the science is robust enough at this point to be useable in the models, even for the projections. Of course there is uncertainty, but that’s what insurers do—they allow societies to grow and thrive in the face of uncertainty.”

Projections and confidence

In August, the IPCC released the first part of the its sixth assessment report, “ Climate Change 2021: The Physical Science Basis”. The report considers different climate scenarios, including global temperatures and sea level rise, offering up projections and outlining the IPCC’s confidence level in such projections.

She explained that the IPCC has projected that sea levels are going to continue to rise and, combined with more intense hurricanes, this will lead to more coastal flooding and inland flooding. The IPCC has medium to high confidence that there will be more frequent extreme rainfall and flooding.

“From the insurance industry perspective, the IPCC’s conclusions with respect to the four perils of tropical cyclones, coastal flooding, inland flooding, and wildfires are the most important thing for modelling companies to focus on,” Clark said.

However, wildfires and flooding are very difficult to model accurately. For example, traditional models of wildfire risk do not truly capture the loss experience we are seeing today, she said.

“Ten years ago, a billion dollar fire loss was a big loss. Now we’re seeing at least a billion dollars every year—last year it was $9 billion from 10 events,” she explained.

“We can’t be going back 50 or 100 years, we need to make sure our models are capturing current climate conditions and giving the insurance industry robust exceedance probability curves based on the current climate.”

The traditional approach has been to use as much historical data as possible, but KCC is now using a physical modelling approach in addition.

“We’ve built actual physical models of the atmosphere and the environment and because these models are always feeding into the current atmosphere variables—all the impacts of climate change are already built in. The scientific approach is to look at what’s happening in the atmosphere, along with what’s happening in historical data, with more emphasis on current data.”

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Live events

One model that is currently being put into use is KCC’s hurricane model, after Hurricane Ida hit Cuba on August 27 and Louisiana on August 29.

Based on its Caribbean and US hurricane reference models, KCC has estimated that the insured loss from Hurricane Ida will be close to $18 billion, with $40 million in the Caribbean and the rest from wind and storm surge losses in the US.

“Since Hurricane Andrew in 1992, this is the eighth hurricane that has caused a loss of $18 billion or more. That’s a return period of about four years for $18 to $20 billion—we used to think of that as a major loss, now it’s occurring with frequency,” Clark noted.

Since she began in the industry, the focus of regulators and rating agencies has been on the probable maximum losses (PMLs) of the 1-in-100-year or 1-in-250-year losses.

“The models are doing a pretty good job there—of course nobody knows what that exact number is. But what’s happening with climate change is that that isn’t the part of the distribution that’s changing. This is important because if you write catastrophe reinsurance, your first and second layers are going to be impacted by the 10-year and 20-year losses.

“If your model is not capturing those losses you’re going to be underpricing your product. Climate change is changing the shape of the distribution,” she concluded.

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