Modeling Woes Heat Up

A review of losses tied to weather-related catastrophes reveals that climate-change models are but one of a growing number of complexities affecting all stakeholders.

Insurance Networking News, February 28, 2013

Pat Speer

For years the insurance industry has debated whether climate change is real and the cause of increasingly severe and numerous weather-related catastrophes, or political hype designed by various environmental and regulatory bodies to force emissions control and reform.

Today, insurers are still playing a game of climate-change "connect the dots." For example, consider the scientific fact that ocean temperatures are rising. Played forward, arguments still ensue over whether the rising temperatures are the direct result of an increase in greenhouse gases, solar activity or the earth's reflectivity. These discussions lead to more uncertainty: Are the rising temperatures directly responsible for the increase in weather-related catastrophes?

Two things are certain: the frequency and severity of weather events are increasing dramatically, as are the insured costs associated with those increases. It's how the industry is responding to these two certainties that has become the biggest topic for discussion.

In January, Bob Hartwig, president of the Insurance Information Institute, reassured attendees at the 2013 Property/Casualty Insurance Joint Industry Forum in New York that the industry is prepared to weather future storms. He said the industry "both entered and emerged from the 2012 hurricane season very strong financially, stating "There is no insurance industry 'fiscal cliff.'"

Superstorm Sandy alone, however, may have caused anywhere from $20 to $25 billion in insured auto, home and commercial lines claims, notes the Insurance Information Institute. Munich Re offers a broader look, stating that in 2012, the United States accounted for 67 percent of overall natural catastrophe losses and 90 percent of insured losses-compared to an average of 32 percent of catastrophe losses and 57 percent of insured losses-with Sandy and the 2012 drought the costliest of those events.

"[Sandy] probably also highlights the whole issue that the industry is trying to deal with, which is 'what is the new normal?' as far as level of catastrophe losses," said Vincent Dowling, managing partner, Dowling & Partners, at the Property/Casualty Insurance Joint Industry Forum. "The last few decades, the losses relative to premium continue to increase, and we have not had 'The Big One' yet."

Upward trends in catastrophe events can be explained by both the growing value of assets damaged, growth of urban areas, and the impacts of increasingly frequent and unpredictable severe weather events, notes Cynthia McHale, director of the insurance program at not-for-profit advocacy group Ceres. "Stormy Future for U.S. Property/Casualty Insurers," a report co-authored by McHale and Ceres senior manager of insurance and water programs Sharlene Leurig, illustrates how during this same 30-year period "the number of natural disasters has increased, particularly those related to climatological events: extreme temperatures, droughts and wildfires, and meteorological events: storms."

From investment information site Motley Fool's long-term warning to investors of insurance securities to "prepare your portfolio for climate change," to S&P's short-term advisory stating that the rating impact on all insurance sectors will be stable to modestly negative in 2013, concern is growing over insurers' ability to weather long-term climate-change related losses.

In the report, McHale and Leurig cite $32 billion in costs to property/casualty insurers related to extreme weather events in 2011. "While 2012 insured property losses to date are lower, the pattern of extreme weather and associated economic costs are continuing," she states. "These rising payouts come as insurers are simultaneously confronting historically low investment returns and a sluggish overall economy. Even before the recent spate of underwriting losses, the insurance industry's overall financial performance, as measured by average return-on-equity, lagged significantly behind other industries."

The Need for Models

It's clear why stakeholders from the scientific, technology and business communities agree on the need for models that incorporate, at a minimum, the potential uncertainties of climate change projections into climate model outputs.

All three of the major vendors in this space, AIR Worldwide, Risk Management Solutions Inc. (RMS) and EQECAT, have reviewed or updated their climate models within the past few years. Yet climate change, by its nature, purports a certain amount of uncertainty, admits David Simmons, managing director, analytics at Willis Re, making this modeling difficult at best.

"Climate cycles, El Nino/La Nina and climate change, are poorly modeled if at all," says David Simmons, managing director, analytics at Willis Re, a global reinsurance broker. "This implies that catastrophe modeling companies must be more open about the assumptions used in their models and how those assumptions were derived."

Peter Dailey, director of atmospheric science at AIR Worldwide, agrees that climate signals such as ENSO (El Nino/La Nina) and the North Atlantic Oscillation are difficult to predict precisely, and that climate trends make such predictions even more uncertain, yet scientists still turn to climate models as their best tools to understand our changing climate.

For more information on related topics, visit the following channels:

• Enterprise Technologies
• Risk Management
• Underwriting