Swedroe: Climate Change & Reinsurance

May 03, 2019

2017 and 2018 were difficult years for the reinsurance industry. 2017 saw losses for property insurers and reinsurers reaching $150 billion (the highest ever) as a result of three major hurricanes making landfall in the U.S., and 2018 saw insured losses of roughly $80 billion, mainly caused by California wildfires and Typhoon Jebi in Japan. The losses increased concerns investors had about the impact of climate change on the industry.

My column of Sept. 21, 2018 discussed several key issues including some of the historical evidence, recency bias, and avoiding the mistake of confusing information with value relevant information.

Given the recent losses and heightened concerns, I thought it important to take a deeper dive into the science of climate change as it relates to reinsurance risks.

Top Climate Change Risks Don’t Impact Reinsurers

In October 2013, three billionaires, Michael Bloomberg, Hank Paulson and Tom Steyer, commissioned a study called Risky Business. They hired a leading economic consultancy, the Rhodium Group, who partnered with Risk Management Solutions, the leading global catastrophe modeling firm, to conduct an objective study of the threats of climate change to the U.S. economy.

In their report “The Economic Risks of Climate Change in the United States,” they identified the four largest economic risks to the U.S. As you will see, three of the four issues do not impact the reinsurers.

  1. Threats to coastal property and infrastructure. Over the next 15 years, the average annual cost of coastal storms along the Eastern Seaboard and the Gulf of Mexico could increase by $2.0 billion to $3.5 billion. Potential increases in hurricane activity could increase the average annual cost by another $4.0 billion. While this scenario would clearly be bad for the economy, it seems likely it would have limited impact on the reinsurance industry for several reasons. First, roughly half the increase is driven by flood risk associated with rising sea levels. Residential flooding is currently reinsured primarily by the federal government through the National Flood Insurance Program, which buys only a limited amount of reinsurance (most losses are borne by the U.S. taxpayer). While commercial flooding is covered by reinsurers, coastal flooding due to sea levels rising is a creeping risk rather than a sudden risk. According to the Risky Business report, if we continue on our current trajectory, sea levels in New York City would rise 2.4 feet to 4.2 feet by the year 2100. This would mean an average of 0.95 inches per year. Because reinsurance contracts renew every year, reinsurers can see this increase in risk coming, and can react in time to incorporate it into pricing and underwriting. Finally, the increase in potential loss from increased hurricane risk is small relative to the existing hurricane risk.
  2. Rising temperatures reduce labor productivity. By 2050, the average American may experience 27 to 50 days above 95 degrees Fahrenheit (a two to three times increase). This means that in some regions it may be too hot for people to work outside during the hottest part of the day. This would impact labor productivity in such industries as construction, agriculture and utility maintenance. While this scenario could have a material impact on affected industries, these economic risks are not insured or reinsured.
  3. Strains to our energy system. As the country experiences hotter summers, demand for air conditioning will increase as well, putting a strain on regional generation and transmission capacity, and perhaps drive up energy prices. Again, none of these additional costs are covered by reinsurers.
  4. Health impacts from heat. The worst health impacts from increasing heat will be felt by the poor, who cannot afford air conditioning, and the elderly, who are too frail to withstand the increased heat. The combined impact of heat and humidity can be dangerous or even deadly. This scenario poses economic and social risks, but the burden will fall on the health care system, rather than on property insurers or reinsurers.

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