Harnessing all the tools in the fight for climate resilience

Spain, Portugal, Morocco and Algeria have all just experienced a scorching April, with temperatures up to 20°C higher than is typical. Meanwhile, torrential rain has led to flooding and landslides in parts of Europe and Africa.

We are surrounded by events showing the effects of climate change are already upon us. Weather extremes, flooding, drought and other natural catastrophes are becoming more severe and frequent. And they are also becoming more costly.

Reducing greenhouse gas emissions continues to be of utmost importance. At the same time, we need to start adapting to the effects of climate change that we are already seeing. And both those imperatives come with a significant price tag.

Facts are that the climate protection gap is real, climate risk is not properly priced and capital markets and public-private partnerships are key to unlocking the additional needed funding. The good news: despite the size of the gap, closing it is possible. Ultimately, insufficient funding to deal with disasters, adaptation and mitigation efforts has both macroeconomic and societal implications. This includes keeping insurance affordable to limit the financial risks and fiscal spending for governments.

As highlighted in our recent sigma report, Natural Catastrophes and Inflation: A Perfect Storm, natural catastrophes cost the world USD 275 billion in 2022. Insurance covered 45% of the damage, at USD 125 billion. This protection gap – the difference between what is covered and actual losses – is significant. Arguably less of a gap and more of a chasm as outlined by Urs Baertschi in his recent blog.

That’s why the discussion right now in Europe about public funds, insurance and natural catastrophes is extremely important. The European Insurance and Occupational Pensions Authority (EIOPA) and the European Central Bank (ECB) are highlighting a number of ways in which the protections gap can be tackled, including through transferring risk to capital markets.

One of the instruments the EIOPA and ECB Staff Paper suggests is cat bonds to support reinsurers. These bonds provide an important way to attract a wider range of professional investors outside of the re/ insurance industry, particularly amid market uncertainty, giving re/insurers a more diversified capital source. Transferring risk for events that come with a low-probability but high-impact helps provide insurance for those kind of risks at an affordable price. Professional investors will be rewarded at the same time with an attractive bond yield.

It is here that re/insurers have a crucial role to play: by pooling risk and transferring it to the capital markets in the form of cat bonds, they can help drive forward the climate change response. Re/insurers help spread the financial burden, effectively increasing the firepower available.

With an overall global bond market size of USD130trn (source: ICMA) and sustainable bond market size being only less than 10% (source: ICMA), there is a lot of potential with the right economic policies. In this respect, more work is needed to develop accepted sustainability market standards for cat bonds (eg ICMA-like) for markets to develop and accelerate the investment flows.

The EIOPA and ECB paper also acknowledges that as natural catastrophe risks grow, policymakers need to consider sophisticated public-private partnerships that are coupled with safeguards and incentives to promote risk mitigation.

Businesses, governments and individuals must respond to the risks we are facing now – and start planning for those on the horizon. We need to recognise that societal resilience relies on us narrowing the protection gap and taking action to ensure that the climate crisis doesn’t exacerbate existing inequalities. Failure to act will place a significant burden on households and businesses, as well as having a wider macroeconomic impact.

The re/insurance industry has a uniquely textured view of the dynamics at play here. Experience, granular data and digital tools are providing crucial insights into the increasingly severe and complex risks these human-induced changes present us with.

Our sigma data shows that insured losses are increasing in the region of 5-7% each year. Managing and limiting these costs demands a much broader awareness and understanding of the risks. Businesses, for example, need to take a long-term perspective on their risk and not rely solely on past experience or historic data to inform future strategy.

In addition, more strategic use of data can improve modelling and help the public and private sectors better understand where risks lie. This will also help close the protection gap, ensuring the right cover is sought and accurate costs are reflected in premiums.

Accurately pricing climate risk is crucial for business and financial institutions to effectively navigate the challenges posed by climate change. It supports proactive risk management, assists other financial market participants to better understand/value the risks taken and drives the transition to a more resilient and environmentally conscious economy.

The re/insurance industry has a strong track record in unlocking financing to accelerate progress. This includes supporting the green transition, as well as helping to develop and scale new solutions to tackle emissions and carbon capture.

However, while the re/insurance industry can help smooth some of the risks involved, it is only part of the solution. Public–private partnerships are vital in this regard, and re/insurers stand ready to support governments and public authorities in their efforts to protect society against the drivers of increasing natural catastrophes while ensuring prices are not reflective of distorted regulatory interventions.

We therefore welcome the initiative of the ECB and EIOPA in contributing to this discussion and opening it to a wider field of representatives.

Limiting the fallout from climate change requires using every tool we have at our disposal. The important role re/insurance has to play in this will undoubtedly be amplified by policy, commitment and investment from the public and private sectors, and we will seize this opportunity to collaborate.