A Captive Solution to Climate Change

19 April 2018

ALEXANDRA GEDGE AND JOSH DARR OF JLT RE DISCUSS HOW CAPTIVES CAN HELP ALLEVIATE THE FALLOUT OF CLIMATE CHANGE

This content was originally published in Captive Insurance Times issue 144

Josh Darr: From a science and policy perspective, there is growing understanding that the planet is witnessing an increase in extreme weather conditions. 

The source of more extreme weather includes elements of climate change, sea level rise, and population growth. In conjunction, these factors are escalating the potential for outsized insured losses. 

In the 2018 World Economic Forum’s annual assessment on risks to the global economy, three of the top five risks across the global economy for impact and likelihood of occurrence included extreme weather events, natural disasters, and the failure of climate change mitigation and adaptation (see exhibit 1). 

Since the 2008 World Economic Forum’s Global Risk Report, environmental risks have moved higher up on the agenda. Where climate change was first rated as one of the largest global risks in 2011, in 2018 extreme weather events and natural disasters were rated as the top two biggest risks the world is facing, with the failure of climate change mitigation and adaptation rounding the list off in fifth place.

Exhibit 1: World Risk Review top risks: According to the 2018 statistics

 World Risk Review top risks: According to the 2018 statistics

Exhibit 2: US Climate Extremes

US Climate Extremes

 

The problem 

As measured by JLT Re, 2017 was the highest year of insured catastrophes globally, driven by North America (see exhibit 2). 

Undoubtedly the series of Atlantic hurricane landfalls, along with historic wildfires in California, were the major drivers of losses. The increasing trend of severe thunderstorm losses is also evident across North America, with elements of changing weather patterns as well as expanding population centers driving the increased loss profile. The National Center for Environmental Information, a division of the National Oceanic and Atmospheric Administration, has tracked the occurrence of specific extreme events over time since 1910. 

In most cases, extreme events are defined as lying in the outermost, “most unusual” 10 percent of a location’s history. The current five-year period between 2013 and 2017 is the most extreme on record. Moreover, the US experienced a cost of $17 billion from weather and climate disasters in 2017 (see exhibit 2), well above the 1980 to 2017 average of six events a year. 

Alexandra Gedge: JLT Re notes  “increasing acknowledgement by many policy groups that we are witnessing an increase in cat events and extreme weather globally”. As all of this data shows the world is experiencing changeable and extreme weather, with subsequent risk to people and to property, which businesses have to deal with. The havoc caused in the UK from the ‘Beast from the East’ and ‘Storm Emma’, which caused England’s first-ever red weather warning to be issued, are an example of the risks that businesses need to be prepared to deal with.

Many risk managers are now utilising their captives to implement some of their risk management plans. 
How can your captive alleviate these risks? The flexibility of a captive in writing unusual risks where the insurance market pushes back, the access to different markets (crucially for many, the reinsurance market), and risk management benefits all combine to give options for risk managers. 
Accessing other markets 

By owning your own insurance company, a business can access reinsurance markets. 

This is crucial to access different, and in many cases, greater capacity. Accessing alternative capital markets mean risk managers can use different risk transfer options, like parametric insurance covers, to manage risks from extreme weather events. 

Alleviating reliance on market 

Take some risk in your own captive, so where prices may increase as markets are reporting huge losses (because large cat claims are hitting their books) you can smooth market fluctuations (see exhibit 3). 

If there is reduced appetite from insurers for your risks and they either withdraw from this risk or become too expensive, plug this gap through your captive. 

This can be done by either filling gaps in coverage, or incubating your risk in your captive to show a good risk profile before transferring to the market.

Munich Re found, in 2016, the protection gap (share of uninsured losses) was 70 percent, so approximately $50 billion. This means it sits on your balance sheet. Part of a lot of captive client business is exploration in new parts of the world, for example the mining industry. These areas are often hard to insure, or places where typically insurance isn’t bought locally or is inadequate. 

We have seen this pattern in some locations in Africa or Asia. These are places where there’s a lot of extreme weather, and often these risks in markets are uninsurable. Equally, work in these places often includes local partners. A way of making sure your local partners in these areas have cover too is offering it through your captive. If your partners here don’t have coverage, you will field a share in their losses. 

Risk management: use your captive’s data 

Kimberly Roberts, vice president and meteorologist at JLT Re, said: “It is becoming more important to gather information on exposure for a specific location, and to map those that are vulnerable to hurricanes, tornadoes and hail.” 

Your captive has a wealth of data on your business and the risks it faces. Even with sophisticated models, cat data is hard to model. As these are extreme weather conditions, there is limited data on tail end weather.

By deploying all the tools at your disposal to create a scientific approach, speaking to your captive manager, with support from cat modellers, and actuaries you can work out your largest exposures, dependencies in your supply chain, and storm and flood risks. If there are potential risks to your business, work with the market to find adequate contingency insurance covers, such as additional increased cost of working, or contingent business interruption cover. 

Use this data to implement a global risk management process. Extreme weather adds new risks in new locations with different regulatory environments. 

An adequate risk fund can support your strategy, and any changes in regulation that arise as a result of the variable weather and environmental risks and changes, like the commitment to the reduction in CO2 in shipping, as discussed during the Maritime Cyprus conference in 2017. Your captive, if running well, can sit centrally to your risk management strategy, and be an essential tool for your business to deal with variable weather and subsequent damage to the business. Ultimately, your captive can assist to keep your business and—importantly— your people safe.

Exhibit 3: Global insured cat losses

Global insured catastrophe losses

 
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