Storms, wildfires and floods: how climate change amplifies insurance risk

Losses from natural catastrophes are on the rise. This is mainly due to economic growth in urban areas at risk. But climate change is becoming more visible as a major risk driver.

When thinking of melting ice caps, few people think of New York. But climate change is amplifying the threat facing America’s biggest city just as it’s endangering other coastal communities, according to Swiss Re Institute's latest research on climate and natural catastrophe risk.

As rising sea levels and erratic weather become an accepted part of daily life, natural catastrophe risks are rising, says the new sigma report, Natural catastrophes in times of economic accumulation and climate change risks. And that puts the insurance industry on the frontline, since these are complex, costly and difficult to price. With the threat steadily increasing, action is needed around the world.

“Weather risk is not constant but variable. Climate change makes the risk even more dynamic,” says Lucia Bevere, Senior Catastrophe Data Analyst at the Swiss Re Institute and author of the report. “It’s an uncertain world and there’s more erratic weather every year. If we wait for these things to become certainties it will be too late.”

While there are still many unknowns, most evidence suggests that the effect on the insurance industry will be multi-layered and complex. In the case of New York City, the estimated 30cm increase in sea levels since 1900 − 20cm of which has been caused by climate change – means that post-storm flooding is worse. And while that’s relatively small in relation to the total volume, the additional water and expansion of the affected footprint are significant.

Gathering evidence

It could take decades to gather enough evidence to confirm what the impact of climate change really is, and by that time the risks may have increased exponentially. The challenge for the insurance industry is to combine science, facts and what’s happening on the ground to create more forward-looking models. This means better capturing the dynamic nature of natural catastrophe risk and not just relying on historic loss data alone. While risk modelling principles still hold, the industry has to track a baseline that reflects today's risk, rather than one of several decades ago.

And it’s not just hurricanes and rising sea levels. Other parts of the world are also succumbing to extreme weather events and natural disasters.

“While the science is still at an early stage, the insurance industry can’t afford to wait and see,” Bevere says. “The number of wildfires and heatwaves tells us something is happening.”

Devastating bushfires ravaged Australia late last year, exacerbated by months of drought and record-breaking temperatures. While global warming doesn’t cause the fires, it amplifies their severity and frequency – a vicious cycle is created with more carbon released into the atmosphere, turning what would have been carbon sinks into carbon sources.

“Much more than climate is changing and that adds complexity,” says Martin Bertogg, Head of Catastrophe Perils at Swiss Re. “While for 2020 climate change is seen as a subordinate factor in the mix of strong trends affecting an evolving insurance risk landscape, in 20 to 30 years’ time, the likelihood is that the changing climate will be the major factor.”

City living

Other factors include the concentration of assets in high-risk areas like floodplains and the urban-wildland interface, increased urbanisation and a general move towards coastal areas, all of which combine to compound the effects of natural disasters and generate losses. More than 50% of the global population live in urban areas today, up from 30% in the 1950s, and that share is forecast to increase to almost 70% by 2050.

“That means there are more people in harm’s way,” Bertogg says. “They are more highly concentrated and there is more absolute loss potential today than a decade ago. Economic losses, inflation adjusted, have grown by a full magnitude in only 50 years.”

A greater number of people are settling on the coast, on former lower-lying swamps or refilled lakes. And that adds another layer, the physical effect of the built environment exacerbating the occurrence of extreme weather: built-over areas develop a micro-climate and essentially, it’s hotter in cities. In addition, open surfaces, estuaries, creeks and swamps that once would have dissipated water from torrential rains are now covered in concrete.

In Japan, the effect of these shifts was keenly felt last year after Typhoon Hagibis caused heavy winds, flooding and landfall. Even as flood protection measures successfully prevented major havoc in the denser portions of Greater Tokyo, levee breaches and overflowing rivers caused exceptional flooding in other areas.

This was surprising since, after huge investment in defences, Japan’s flood risks were considered to be largely mitigated. Together with Faxai in the same year, these two typhoons and the damage that followed were the biggest loss events of 2019.

Fresh thinking

"What’s needed is a shift in the way insurance models are configured towards a more forward-looking risk assessment," Bertogg says. "Such an approach incorporates trends  that have already added to the risk we're observing today. This is in stark contrast of averaging out a long distant past of decades or even centuries, a common way to define a model's baseline risk."

Future proof models are a prerequisite for the insurance industry to help close the protection gap, which has been widening and leaves households, businesses and economies vulnerable to more extreme weather.

Caption: The protection gap has widened over time

Source: Swiss Re sigma report, Taking stock: natural catastrophe insurance in times of economic accumulation and climate change risks

Confidence is central to a new approach. While it’s possible to talk fairly confidently about the impact of melting glaciers, it is less certain how climate change affects the frequency of tropical cyclones or flood risk.

It's less certain how climate change affects the frequency of tropical cyclones or flood risk.

Low levels of confidence in how certain elements relate to one another mean they’re often left out of models altogether. However, given their increasing frequency and likely material impact, they can’t be ignored.

Becoming surer

“We need to make sure our confidence is higher,” says Michael Gloor, Senior Natural Catastrophe and Climate Specialist at the Swiss Re Institute. “These are massive risks and we all need to work on increasing the level of confidence by studying them more closely. That’s something that the insurance industry is working on, that academia is working on.”

Classification of climate-change effects and relevance for the re/insurance industry

More research is needed from across the industry, to help clarify some of these highly uncertain aspects − for example, a warming climate affects hurricane frequency, and this will require collaboration with data scientists, environmental scientists, meteorologists and other academics.

How different governments respond will also contribute to the evolving picture, with stark differences between developed and less-developed countries.

The Dutch government has taken strong action to protect Rotterdam in the Netherlands against rising sea levels, using adaptation measures based on water management and spatial planning. In contrast, Beira in Mozambique, built on similar low-lying land to Rotterdam, hasn’t invested in flood-risk mitigation measures, leaving it vulnerable to natural disasters.

Intensifying effects

In March 2019, Cyclone Idai hit Beira, generating an economic loss of $3 billion, the costliest weather event in Africa on sigma records. The insurance cover was just $150 million.

Most evidence points toward an increase in events like these. 2019 was the second-warmest year on record and patterns of severe weather are changing and intensifying with drought, wildfires and floods becoming more commonplace.

The sigma report underscores that, by the time data can conclusively show how much each degree of warming increases certain risks, the losses and the threats may have spiralled out of control. Without action, that’s the future, it concludes.

“The whole industry needs to look forward and work out what the impact of these factors will be,” Bertogg says. “Climate change, urbanisation and coastal living. They all contribute to a dynamic landscape that you have to track, to take well informed underwriting decisions today already.”


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