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Accounting for Climate Change in the Reinsurance Industry

Posted on Jul 14, 2011 by Sergio Ulloa ()

2011 has been a crushing year for the reinsurance industry, with a slew of destructive natural disasters leaving huge damage claims in their wake and putting reinsurers under intense financial pressure.

Munich Re, the world's largest reinsurer, spoke for the reinsurance industry this week when the company reported that insured losses for the first half of 2011 are five times the average since 2001, with economic losses totaling $265 billion. This is due to an "exceptional accumulation" of intense natural disasters, such as the Japan earthquakes, the Christchurch earthquakes in New Zealand, the floods in Queensland, Australia, and the tornadoes in the USA.

Munich Re's specific monetary losses are not due to a lack of planning, however. Board member Torsten Jeworrek said that Munich Re was "not surprised by any of the events when seen as single events, since they were within the range of what our risk models led us to expect. The accumulation of so many severe events of this type in such a short period is unusual, but is also considered in our scenario calculations." However, CFO Jorg Schneider did say that "the earthquakes in Japan and the natural catastrophes in Australia and New Zealand have made this the most difficult start to a financial year that we [Munich Re] have experienced for a long time." Munich Re's first quarter losses totaled $1.3 billion, while Swiss Reinsurance Co (Munich Re's greatest rival) lost $665 million and Allianz SE and Axa SA had their costliest first quarter ever. David Smith, a senior vice president of Eqecat, a US company that advises the insurance industry on catastrophe risk management, said that "an average annual loss for severe convective storms - tornadoes, hail, thunderstorms, and wind-is about US$ 6 billion."

In Japan in March, the earthquakes killed 16,000 people and damaged/destroyed 125,000 buildings, leading to insured losses totaling $30 billion, making it the costliest and most damaging natural disaster of the aforementioned events.

In New Zealand, the Christchurch earthquakes caused US$20 billion of damage, with US$10 billion specifically from insurance. The Christchurch earthquakes were the third-costliest earthquakes worldwide, damaging hundreds of buildings and homes and also managing to completely destroy buildings that had been previously damaged by the 2010 quakes. IAG has increased premiums in New Zealand by 15-20 percent in order to compensate for the resulting climbing reinsurance costs.

Severe flooding occurred in Queensland at the beginning of this year, flooding homes and businesses before Australia's first Force 5 storm in 100 years hit in February, with winds traveling at over 280 kilometres per hour. RBS analyst Richard Coles said that "Aon has noted that Australian insurers are seeing price increases ranging from 15 to 70 per cent, while Willis Re says rate rises are closer to 30 per cent for Australian loss-hit catastrophe risk."

Southern and Midwestern America have also been hit hard by natural disasters such as storms, flooding, fires, and earthquakes this year, with US$27 billion in economic losses. Munich Re reported that this is more than double the 10-year average of US$11.8 billion, and Carl Hedde, a risk analyst for Munich Re, suspects that 2011 will be "the year of the tornado." Bob Hartwig, head of the Insurance Information Institute said that the upward trend the amount of events in the United States "is pushing up the cost of providing insurance in many parts" and that "insurers have begun to reflect that in their rates and will continue to do so."

These natural disasters are causing reinsurance companies to evaluate their risk policies and plan more for the future, as theories continue to develop on the negative effects of climate change. Last year was ranked one of the warmest years ever recorded by the World Meterological Organization, supporting the theory of a "long-term warming trend." Nikola Kemper, Munich Re's media chief, affirmed this, saying that "it would seem that the growing number of weather-related catastrophes can only be explained by climate change." The effects of this trend could be devastating to the reinsurance industry, as warm air holds more water, ultimately creating more evaporation which generates energy to intensify droughts, floods, and storms. In order to maintain profits, companies may have to raise premiums, declare certain areas uninsurable (i.e. refusing coverage to customers who have property on top of floodplains), and simultaneously insure "green technology" that hopes to slow warming. Munich Re is one company that is doing its part; it has partnered with the London School of Economics in order to discover "more detailed information on the link between climate change and the observed increase in losses due to weather extremes." Munich Re is also providing warranties for US company SolFocus' solar-power systems. Insurance companies could also reduce premiums for customers and companies that have "greener" buildings.

The agricultural sector will be especially affected by possible rising insurance premiums. Grain harvests in Russia and Australia have suffered from droughts this past year as vegetable prices in China have increased by 40 percent due to flooding there. Although rural villages and food prices will continue to be negatively affected if insurance premiums do rise and risky areas are denied coverage, there may be a positive effect on climate change, as governments may be forced to address more sustainable environmental policies for consumers and companies that produce fossil fuels.

As insurance companies and reinsurers cope with the risks of a world whose climate is changing, people must be willing to do their part to lessen global warming and protect society, the environment, and the economy. Based on the rising numbers of natural disasters this year, if the government does not make more of an effort, it will surely be the taxpayers, insurance industry, and most importantly, the environment, that suffers. As Bob Hartwig, head of the Insurance Information Institute, summed it up, 2011 is "one for the record books" and that "we are rewriting the financial and economic history of disasters on a global scale."

Insurance Companies Mentioned:

Swiss Re: As the second-largest re-insurer in the world, Swiss Re maintains a presence on all continents, providing reinsurance for Property and Casualty and Life and Health related issues, as well as risk management services for corporations.

Munich Re is one of the world's largest reinsurers, focusing on financial stability, risk management, insurance, reinsurance, and health. Munich Re is an international company that employs over 47,000 people all around the world.

IAG: Insurance Australia Group provides personal and corporate insurance policies under several different brands, including NRMA Insurance, CGU, SGIC, SGIO and Swann Insurance. In addition to being the largest general insurer for Australia and New Zealand, IAG is expanding out of its home markets and looking to Asia. Aon: With over 80 offices in 50 countries, Aon is an international insurance company that provides risk management and catastrophe management services while also working with entertainment companies.

Allianz has a growing international presence, employing over 153,000 people and providing services to about 75 million customers in 70 countries. The company provides insurance and asset management while it commands the German market especially.

AXA offers life insurance, health insurance, and asset management services. A worldwide leader in financial serivces, AXA has operations in Europe, North America, and across Asia-Pacific.

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