Understanding and transferring climate risks: 2 takeaways from WRMA European Event 2022
Key Takeaways:
- Buyers of insurance need to understand their risks better to become more confident with parametric products
- Climate change risk reporting makes parametric risk transfer more relevant
WRMA is a market association of insurers, reinsurers, brokers, risk managers and data providers involved in weather risk transfer, including the parametric insurance and weather derivatives markets. It runs annual meetings in Europe and the US and aims to promote weather risk management and bring together market participants.
The WRMA European Event highlighted that the need for parametric solutions to cover climate risks is growing. Traditional insurance is getting more expensive and climate change is making weather and catastrophe events more frequent and severe. At the same time, parametric insurance is a growing market but it is still relatively niche. For more insurance buyers to become confident in parametric solutions, they need better access to information about the risks they face.
Whilst indemnity insurance policies are designed to compensate policyholders for loss, parametric insurance pays out claims based on event triggers. Common triggers involve weather or natural perils, such as hurricanes measured by wind speed, or floods by high water mark.
1. Buyers of insurance need to understand their risks better to become more confident with parametric products
While the insurance industry is experiencing a ‘hard market’ (meaning premiums increase year on year), the global economy is slowing down and inflation is surging. As a result, many risk managers are on tighter budgets while their company’s insurance becomes more expensive.
At WRMA, a panel representing European risk management associations AIRMIC, AMRAE and FERMA discussed how risk managers approach parametric products. Given the hard market and budget constraints, risk managers are increasingly looking for coverage customised to their exposures, rather than more expensive ‘blanket’ coverage limits (which cover multiple locations).
While several insurers and MGAs now offer parametric solutions that can help to fill gaps in traditional coverage, parametric insurance is only part of the solution. Risk managers also need help to understand key information such as the physical attributes of their property portfolio, the types of perils they are exposed to, the potential losses that can arise and the probability of these losses occurring.
The panel of risk managers said they would like their insurers to provide more information about their company’s exposures so that they can make a more informed decision on their insurance options, including whether to choose parametric insurance. A better understanding of their company’s exposures would increase risk managers’ confidence that a parametric policy would pay out predictably in the event of a loss. Fear of buying the wrong insurance product, one that would fail to pay out when a loss occurs, can still hold back companies from choosing parametric solutions.
A WRMA panel of the insurance industry, representing Swiss Re, Munich Re, Descartes Underwriting and MSI GuaranteedWeather (part of Mitsui Sumitomo Insurance Group), also touched on how clients’ understanding of their exposures affects their insurance purchasing habits.
Descartes Underwriting’s Co-founder and CEO Tanguy Touffut explained that changing climatic conditions are making forests in some Nordic countries newly susceptible to damaging wildfires. Organisations may not realise they are underinsured, since there is not a history of damaging wildfires in the region.
Purchase of parametric products is strongly affected by recency bias. Companies that have experienced a recent loss are more concerned about future losses from the same peril and willing to buy cover. Conversely, companies are less likely to buy a parametric insurance product against a peril that has not affected them recently, even if there is a high risk of potential loss. For example, few companies bought pandemic coverage before COVID-19, even though some insurance products were available.
If organisations could access more information about their exposures to natural perils and weather risks, both risk managers and insurers at WRMA agreed that they would be more likely to purchase parametric covers.
InsTech’s recent report, Parametric Insurance in 2022: the 150+ Companies to Watch, sets out opportunities in the parametric insurance market today and how companies are responding to challenges in the market. You can purchase the report on InsTech’s website, free to InsTech corporate members.
2. Climate change risk reporting makes parametric risk transfer more relevant
Climate change is making various weather and catastrophic events more frequent and severe. This exacerbates the problem of recency bias; organisations may be more exposed to climate perils than they think and risk being underinsured.
For example, SCOR’s Raphael Bidinger explained at WRMA that climate change is making California forests drier for longer, because temperatures are increasing and snow is drying more quickly, which increases wildfire risk. Luca Brocca from the National Research Council of Italy discussed the 2022 European heatwave; changes in the European climate are making such events more likely in the future.
A growing number of companies are disclosing how changes in the climate will impact their operations. The Taskforce on Climate-related Financial Disclosures (TCFD) is the most widely used reporting framework.
CelsiusPro’s Founder and CEO Mark Rueegg gave a presentation to WRMA about the analytics needed to measure climate change risks within the TCFD framework. In countries such as the UK, Switzerland and Canada, some companies face mandatory TCFD reporting, and voluntary reporting is increasing elsewhere in Europe and the US. To be TCFD-compliant, companies must report on how climate change will affect their global operations, which requires data collection, risk modelling and future scenario analysis. Many companies will not be able to perform this in house but will work with third parties such as CelsiusPro to calculate and report on their risks.
Mark Rueegg demonstrated how TCFD reporting enables companies to become aware of the climate risks they face, possibly for the first time. This awareness in turn empowers them to identify the most appropriate solutions to transfer these risks. Companies that can offer climate risk modelling solutions, parametric insurance products and TCFD reporting consultancy services are well placed to support clients in this process.
You can learn more about climate change risk reporting by reading InsTech’s report, Climate Change Risk Regulation and Measurement: 22 companies to know. The report is currently free to download.
What’s next for the parametric insurance market?
When asked whether they were optimistic or pessimistic about the future of parametric risk transfer, WRMA’s panel from the insurance industry was unanimously optimistic. Parametric insurance for climate risks is a growing market and is expected to grow further, though it is still niche.
Discussions at WRMA hinted at what factors could make parametric a more mainstream insurance product in the future. As large numbers of companies are required to report on the climate risks that affect them, they will understand their exposures better and could be more open to parametric solutions. Brokers and modelling companies have an opportunity to increase awareness and uptake of parametric solutions by providing TCFD consulting services.
Where organisations choose parametric insurance for climate risks, it should be as part of a wider climate risk management strategy. One risk manager on the WRMA panel said they would like to see parametric insurance products looking more like cyber insurance products in the future, in that cyber insurance is often sold with value-add services that help businesses recover from loss events. Parametric insurance can support businesses financially when climate events cause business interruption losses, but organisations would also benefit from other loss mitigation services to help get their business back up and running.
For organisations to manage their climate risks effectively, they need to understand their climate risks better, transfer them effectively and be able to recover after climate events cause losses. The future role of the insurance market will include helping its corporate clients manage their climate risk across a broader range of services, from climate modelling to parametric products and value-add services.
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