Averting a collision course with climate change
Don't let the jargon fool you. 'Secondary peril' may sound like something trivial, but it's anything but. In our industry, the term usually refers to natural hazards that are moderately severe and occur fairly regularly: heatwaves, landslides, torrential rainfall or localised flooding. They're often a side effect of larger 'primary' natural catastrophes like hurricanes and earthquakes, the type of events that capture most of the headlines.
Yet this distinction is becoming increasingly obsolete. At worst it’s dangerously misleading. Consider last year's wildfires in California, the floods in India or the droughts in Europe – by definition secondary catastrophes, extreme weather events like these are happening more frequently. And they are increasingly responsible for most of the damage. As the Swiss Re Institute points out in its newest sigma report, secondary perils caused over 60% of all insured natural disaster losses in 2018. Even when mega events like Hurricanes Harvey, Irma and Maria broke new records the previous year, over half of all insured losses were actually driven by secondary perils.
So what's behind this trend? Much of it is the result of two clashing phenomena: the local occurrence of more extreme weather due to climate change and the relentless sprawl of urban centres in precisely those areas most affected, such as coastal regions or the urban-wildland interface. The collision of climate change and urban growth is adding a new twist to an old story about the risk of weather-related disasters and underinsurance.
Building climate resilience
The costs of natural catastrophes have been rising for years. And most are not covered by insurance. As a result, millions of households and businesses face a large and widening protection gap. Globally, this gap amounted to an annual average of USD 129 billion over the last ten years. That means about two-thirds of yearly catastrophe losses were not insured between 2009 and 2018. The main factors behind the widening protection gap are population growth and urbanisation in disaster-prone regions while the provision and purchase of adequate insurance solutions is lagging behind. They expose many more people, businesses and assets to the risk of catastrophic losses.
What's new is that climate change is fuelling the risk that communities face from extreme weather and related secondary perils. Rising temperatures and heavier precipitation are likely to increase the damage caused by wildfires, drought, heatwaves, torrential rain and flooding in many locations around the world. If unmitigated, some of these risks may become uninsurable in the future. This would widen the protection gap even further and severely inhibit our ability to help people get back on their feet after a disaster.
In the face of all this, we’ve reached a defining moment as an industry. More than ever, our long-standing efforts to narrow the gap in insurance coverage for natural catastrophes must converge with our broader actions on climate change and our support for more sustainable business models. This also applies to our own underwriting and asset management practices.
Clearly, a challenge of such magnitude as climate change requires strong collaboration between insurers, their reinsurance partners, as well as clients and partners from industry and the public sector. It's about working together to make our world more resilient – whether it's protecting households, businesses, critical infrastructure or supply chains.
Underwriting risks sustainably
In this respect, tackling the protection gap provides us with an important opportunity. Until recently, historic loss data may have been enough to map, price and underwrite risks. But in a world of expanding urbanisation and a changing climate, this approach is unlikely to be effective in the future. As the rising costs of secondary perils show, underwriting catastrophe business profitably means not just looking at peak risks associated with hurricanes and earthquakes. It also means considering forward-looking trends linked to rising temperatures and heavier precipitation, which are strongly magnified by the continued expansion of cities in regions such as the wildland-urban interface, former floodplains and coastal stretches.
For us in the insurance industry, this is a wake-up call to develop more robust and effective modelling tools that capture climate patterns and environmental changes in real-time rather than in hindsight. Making use of the latest technology available, we can now develop regionalised models that help to assess the local risk posed by weather-related secondary perils. Such insights should give us the confidence to offer a greater product range and make targeted distribution for catastrophe covers a viable option.
For example, when it comes to protecting households against increased levels of flooding, we can now use satellite imagery and cutting-edge algorithms to be more accurate in our flood modelling than ever before. With this approach, we've helped a local insurer in Florida to offer flood insurance protection to people who had never previously been covered. Likewise we work with governments and city planners to make sure everyone has adequate levels of flood insurance, and that flood defences are cost-effective and sustainable.
Together, our industry can also build resilience through our investment decisions, particularly by funding more sustainable infrastructure projects – whether that's transport networks, green buildings, smart grids or offshore windfarms. According to the Swiss Re Institute, the global re/insurance industry has total assets under management of about USD 30 trillion – that's roughly three times the size of China's economy. Even a small part of this sum could unlock a significant amount of capital for infrastructure projects that both protect against the worst climate impacts and support the transition to a low carbon economy.
To speed up such investments, however, we need to lower the barriers for private sector funding. At Swiss Re, we have been investing in infrastructure debt since the early days of our company's founding. But infrastructure projects remain notoriously difficult to access. A transparent and standardised infrastructure asset class on a global level would help unlock the global USD 80 trillion institutional investor capital that is available. This will only happen with more collaboration and open sharing of data about the performance of infrastructure assets.
As climate change is fast rising to the top of our industry's agenda, related sustainability considerations must become a number one priority too. For us at Swiss Re and for many of our clients, this has meant stepping up efforts to advance the transition to a low-carbon economy.
On the investment side of our business, we therefore consciously channel part of our fixed income portfolio into green bonds and allocate a portion of our infrastructure investments to renewable energy operations. In our underwriting, sustainability means we will no longer support projects that harm our planet. For example, we adopted a thermal coal policy last year which commits Swiss Re to no longer underwriting any business with more than 30% thermal coal exposure. Instead, we're looking for new growth opportunities elsewhere, such as supporting the renewable energy industry or partnering with clients and governments to develop scalable solutions to mitigate and adapt to climate change.
Despite these steps, our climate will continue to change and further exacerbate the impact of extreme weather events on local communities. More frequent occurrence of flooding, drought, wildfire and other weather-related catastrophes will remain a reality in many places around the world. This is why strengthening industrywide collaboration and partnerships with the public sector is critical to foster climate-smart innovations and continue to offer protection against the risk of natural catastrophes.
Together, we have the knowledge, technology and capabilities to make the world more resilient to the effects of climate change. Let's step up our collective effort to shift mindsets, business practices and actions to make it happen!