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Home::How Climate Change Distorts Risk Prediction

November 26,2019

How Climate Change Distorts Risk Prediction

Photo by GEORGE DESIPRIS from PexelsBack in the days when Johnny Carson was host of "The Tonight Show," he joked about what he saw as the four seasons in southern California: earthquake, wildfire, rain and mudslide. Now that the first big rain of the season is set to hit California over the next few days, I found myself thinking about what may come next—and into the breach stepped my friend and frequent co-author Chunka Mui with a challenging column both on the fundamental problems that climate change poses and on how insurance needs to step up to the challenge. (That's where you all come in.)

The core issue is timing, as Chunka explains in his Forbes column. Even in areas such as in Florida where rising sea levels are a known problem, 30-year contracts are being written for municipal bonds and mortgages, based on historical data. But past isn't prologue where climate change is concerned, and a timing disconnect arises because insurance on those 30-year contracts is arranged annually.

What happens in 15 years if sea levels rise so fast that a property that can, today, be insured for a modest amount is seen as being at far greater risk? In 20 or 25 years, could many municipal projects and considerable real estate carry such high insurance premiums that they lose enormous value or even become worthless, while municipalities and property owners must continue to meet their payment commitments?

The Florida economy depends on its real estate values, and we don't have to go far into the past to find perilous analogies, where banks made long-term commitments based on short-term borrowing, only to see short-term rates soar. 

The answer would seem to be two-fold. First, those making the commitments to repay the bonds and mortgages will want insurance innovators to set premiums that bridge the one-year versus 30-year disparity, ideally offering a 30-year insurance contract. Easier said than done, right? So, second, innovators will need to become far, far better at predicting climate change so that rates can be based on projections, not irrelevant historical data, and so that municipalities, builders and prospective property owners can get economic signals about projects they should avoid.

In reality, the best result, at least initially, will probably be a hybrid. Longer-term insurance contracts (or commitments in capital markets) may be offered based on sharper projections, but with some ability to raise premiums if sea levels rise much faster than expected.

A look at our Innovator's Edge database on insurtechs finds that there are plenty of companies on the case. Nearly 90 identify themselves as focused on climate change, and we'd say that a portfolio of about a dozen have good prospects for making a dent, on issues ranging from analytics and artificial intelligence to sensors and smart homes.

Chunka has seeded a lively discussion on the topic at LinkedIn, and I'd encourage you to join in if you have any interest. Comments would also obviously be welcome here. How to price climate change risk is a hard, hard problem—one that deserves the full attention of the insurance community and that I'm sure we can tackle, if not solve outright.

Have a great Thanksgiving.

Paul Carroll

Editor-in-Chief

 

 




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