Swedroe: Climate Change & Reinsurance

May 03, 2019

Misleading Headlines

Let’s now turn to another important issue: Headlines are often misleading because the media’s goal is to draw attention/interest—if it bleeds, it leads.

 Let’s look at a Jan. 10, 2019, article from the New York Times. The headline trumpets “Ocean Warming Is Accelerating Faster Than Thought.”  They present a graph showing that the shallower (between 0 and 800 meters) ocean heat content has been increasing dramatically over the past 80 years. Since warmer sea surface temperatures provide more energy to hurricanes, you’re left to draw the conclusion that hurricanes are also increasing in frequency or severity.

However, oceans are warming more rapidly near the poles than near the equator. In terms of U.S. hurricane risk to reinsurers, what we care about is the sea surface temperatures in the tropical regions of the North Atlantic. Data from the National Oceanic and Atmospheric Association (NOAA) website shows there has been no trend at all in North Atlantic sea surface temperatures. In fact, they are basically the same as they were from 1940 through 1960, and they oscillate in a cycle called the Atlantic Multidecadal Oscillation (AMO). According to NOAA, the cause of AMO is a decades-long cycle of ocean waters circulating from north to south and back again.

Using the data, Stone Ridge has found that, while there was a 0.46 correlation between rising sea surface temperatures and hurricanes forming, there was very little correlation (just 0.16) between rising sea surface temperatures and landfalling hurricanes.

The explanation for this lack of correlation is provided by the scientific theory suggesting that wind shear increases when sea surface temperatures are warmer. Wind shear happens when winds in the upper atmosphere are moving at a different speed from winds at a lower altitude. This effect tends to break up hurricanes before they can make landfall.

Adapting To Wildfire Risk

There’s another important point we need to cover: Insurers adapt to increasing risks by changing underwriting requirements.

Wildfire is one risk where climate change may be impacting the severity of insured losses. Prior to 2017, the costliest wildfire years in the U.S. caused less than $2 billion of insured losses.

However, 2017 and 2018 saw insured losses from wildfires of $15 billion and $19 billion, respectively—wildfires have become not only more frequent but also costlier over time. Some of this is due to forestry practices, and some may be linked to climate change. In addition, we continue to build homes in the wildland-urban interface, the areas with the highest exposure to wildfire risk.

The insurance industry has reacted in several ways. First, it has now incorporated the greater risks into risk models, justifying significantly greater premiums. Second, it has adapted underwriting standards.

For example, one major insurer has started refusing to renew policies in high-risk areas unless homeowners conform to California Department of Forestry and Fire Protection (CAL FIRE) guidelines for wildfire safety. These guidelines require that a 10-foot radius around the home, the land be kept “lean, green, and clean,” cleared of anything flammable, such as trees and bushes.

Through stricter underwriting requirements, primary insurers are reducing the risk of insured losses to wildfires.

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