KBWP - Climate Change: Beyond The Headlines

2023-11-28 01:50:00 ET

Summary

• Beyond climate change, we believe the roles of exposure growth and population shifts in driving rising natural disaster losses could reveal unexpected opportunities in the ILS market.
• Rising natural catastrophe losses have been a major focus for insurance-linked securities (ILS) risk managers.
• Climate change is often cited as the primary reason for this insured loss growth.

By Lauren Crane

Beyond climate change, we believe the roles of exposure growth and population shifts in driving rising natural disaster losses could reveal unexpected opportunities in the ILS market.

Rising natural catastrophe losses have been a major focus for insurance-linked securities ((ILS)) risk managers.

Climate change is often cited as the primary reason for this insured loss growth, and while it is a significant long-term influence on natural catastrophes, exposure growth and population distribution changes appear to be the leading drivers of elevated insured losses.

Furthermore, because ILS are short-term exposures while climate change is a long-term trend, we believe extreme perception of climate change may present an opportunity rather than a threat to the ILS market.

Global insured losses attributable to natural hazards in the first three quarters of 2023 were above the 21st century average with an estimated $93bn, of which 65% can be attributed to tornado, hail and/or thunderstorm events (referred to as Severe Convective Storms, “SCS”). ¹

Climate change is frequently named as the usual suspect for increasing losses, but year-over-year growth in exposure, driven by construction in high-risk areas and inflation, has actually had a far greater short-term impact. ²

According to a recent Aon report, SCS losses from 1900 to 2022 have increased at an annual rate of 8.9%.

However, the report cites little change in key “atmospheric ingredients” that influence SCS; instead, the analysis suggests that the uptick in insured losses associated with SCS has significantly more to do with differences in exposure.

In fact, the combined impacts of GDP growth, property cost inflation, and population distribution changes amount to an annual 8.6% increase in exposure, meaning over 80% of SCS loss growth can be explained by exposure changes. ³

In addition to SCS losses, exposure growth is considered a dominant driver of hurricane losses. According to the National Oceanic and Atmospheric Administration’s “State of the Science” report, though changes in hurricane intensity have been observed, there is widespread agreement that increases in population, wealth, and infrastructure values in hurricane-prone regions explain more of the loss growth over the past century. ⁴

As rising catastrophe losses drive increased demand for protection, and thus potentially advantageous pricing for ILS investors, we believe ILS offers a unique source of portfolio diversification and profitability while promoting sustainability, disaster relief, and global societal resilience. ⁵

Sources: (1) Gallagher Re Natural Catastrophe Report Q3 2023 , 10/18/23; (2) Verisk Natural Catastrophe Report , 9/8/23; (3) Aon SCS Report , 9/11/23; (4) NOAA State of the Science: Atlantic Hurricanes and Climate Change , 5/2023; (5) World Bank: Catastrophe Bond Funding Program.

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