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Jul 3, 2023

Climate Science is the Future of Risk Assessment for the Property and Casualty Insurance Market

By: Reagan Ewing

Natural disasters are more frequent, more intense, and more costly than ever. Natural disasters are now a staple in traditional and social media news, as seen with the recent coverage of the Canadian wildfires. These environmental changes mean changes to many industries, including property and casualty insurance.

The business of insurance is the transfer of risk from one party to another.  The policyholder transfers the risk to an insurance company, who, in turn, transfers the risk to reinsurance companies.  Historically, an insurance company would determine if it would accept a risk based on past and present factors or variables of a property. However, as our environment dramatically and rapidly changes, insurance companies are re-evaluating not only the appetites for risk but also the predictions for risk.  

Since 1980, the U.S. has seen an increase in the number of natural disasters.[1]  Between 1980-1989, the U.S. suffered 33 billion-dollar disasters with a combined cost of $209.9 billion, and averaging 3.3 events costing $21 billion per year.

In the 1990s, those numbers increased to 57 billion-dollar disasters with a combined cost of $320.5 billion, increasing the yearly average to 5.7 events with a yearly cost of $32.1 billion. The 2000s saw an increase of 1 event per year to 6.7 for a total of 67 events, but an almost double increase in the costs—the yearly average jumped to $59.5 billion, with a combined total of $594.6 billion. The 2010s saw twice as many billion-dollar disasters as the previous decade with 131 events with a combined cost of $949.5 billion.

The first three years of the 2020s saw more billion-dollar events than the entire 1990s decade. In 2022, the U.S. suffered from 18 billion-dollar disasters costing $175.2 billion. That is 80% of the cost for the entire 1980s. The National Oceanic and Atmospheric Administration reports 9 confirmed weather/climate disaster events for 2023 with losses exceeding $1 billion as of June 8, 2023.

Therefore, it comes as no surprise that insurance companies are reevaluating their risk appetites in states seeing significant increases in natural disasters. States such as “Florida, North Carolina, Louisiana, Colorado, Oregon and California have all seen insurers fold, cancel policies or leave the state after repeated floods, hurricanes and wildfires.”[2]

Historically, insurance companies evaluated risk by looking at past events and current factors to predict the future of a potential risk. The rapidly changing and intensifying extreme environmental make-up demonstrates how the historic approach is out of date; the present and future no longer look like the past.

Earlier this year, the U.S. National Science Foundation and the National Oceanic and Atmospheric Administration entered a new agreement to “support the creation of an Industry-University Cooperative Research Center focused on modeling catastrophic impacts and risk assessment of climate change to better support the needs of the insurance sector.”[3] A better understanding of the potential frequency and intensity of natural disasters will provide insurance companies with more information that they need to successfully adapt to the evolving risk markets.

The data from these new research centers also will provide critical information for planning and development of communities in high-risk locations to become more resilient in the face of natural disasters. It will be equally appealing to the secondary insurance markets of catastrophe bonds and other insurance-linked securities and reinsurance as the investible environment grows.

Catastrophe bonds (also known as CAT bonds) are bonds that insurers or reinsurers purchase to transfer the risk of the costly natural disasters. CAT bonds typically cover natural disasters based on two elements:  1) type of hazard event (wildfire, windstorm or earthquakes), and 2) physical region. Prior to the issuance of a CAT bond, the carrier quantifies catastrophic risk, which is accomplished through risk assessment models that estimate the probability the conditions for a payout would be met over the life of the bond.

Climate science already influences every tier of the property and casualty insurance market. Instead of being passive and reactive to our changing climate, climate science will aid in providing a more accurate prediction of the future and more well-informed risk assessments. Communities will be able to plan and invest in themselves so they are better prepared when Mother Nature knocks on their front door.  Commercial insurers will be able to adjust their businesses to meet the needs for the market while ensuring they remain solvent. While the future always remains uncertain, climate science can help the insurance sector and affected communities see what the future might hold.