Moody’s RMS panel: Time is running out for insurers to act on climate change

The key takeaway in a panel hosted by The Insurer TV in conjunction with Moody’s RMS was perfectly summarised by Lloyd’s director of portfolio risk management Kirsten Mitchell-Wallace: “We can't yet definitively see the impacts of climate change in Cat claims, but by the time that we can, it will definitely be too late.”

The insurance sector needs to stop modelling perils from “past experience” and start factoring in future climate change now, she added.

For Mitchell-Wallace, the continued use of the term “secondary perils” is emblematic of the sector's inability to correctly engage with climate change.

“That's something we need to finally phase out, the use of the term ‘secondary perils’, because I think it's not helpful,” she said.

Mitchell-Wallace views the current nomenclature as a failure because it doesn’t properly categorise those perils which are likely to cause damage to an insurer's portfolio. A likeliness that she said is directly correlated to the propensity of the perils' intensity to be affected by climate change.

“Perils are either peak or non-peak to your specific portfolio,” she said.

“What we're really concerned about is everything that impacts the profitability of a portfolio. What's the big issue at the moment? Obviously, it's climate change,” she added.

Mitchell-Wallace said one path the industry needs to take to address the challenges of climate change is sourcing better talent.

“[Insurers] can’t just simply move their loss ratios a couple of points and say that you considered climate change. It’s not enough. They need to have the people in the insurance companies who understand the science and interpret it,” she said.

Mitchell-Wallace added that insurers needed to broaden their understanding of climate change in nat cat modelling and look at how they are incorporating models into existing systems.

“In my position I hear a lot of model bashing,” she said. “I hear a lot about models and how bad they are. Models are obviously a very useful tool and inform good portfolio management and risk transfer too. I think we just can't blame poor results on the models. Models are tools to be understood, to be interrogated, and really to be integrated into the business,” explained Mitchell-Wallace.

Mitchell-Wallace was keen to add that she views models as “an amazing way to quantify the risks” that climate change poses to the industry.

“Having a system of quantification that is trusted by all of the partners in the risk transfer chain, I think that's something amazing that models have given us,” she said.

Climate change means model change

Maurizio Savina, vice president of product management at Moody’s RMS, said models need to innovate to keep up with the changing risk environment imposed by climate change.

Agreeing with Lloyd’s Mitchell-Wallace, he said the industry needed to stop solely looking backward when quantifying climate change, likening the approach to driving while “looking at the rear-view mirror”.

One of the points he made in validating this claim was how Moody’s RMS had factored in the chance of unprecedentedly large Italian hail in its recent model.

“For instance, we had the case of hail stone size of 16-18 cm in Italy, never observed and record-breaking in Europe. In our models, for Italy SCS, we accounted for 16-19 cm hail stone size. We modelled the possibility. So, it's very important to complement and to make best use of all the data that is at our disposal, of course, of the market,” he explained.

Climate change is imposing the need to model the unexpected and has led to Moody’s RMS going in the direction of modelling events with increasingly low annual exceedance probabilities.

As Savina explained, as the climate becomes more unstable the need to model these tail risks grows, to help firms avoid bankruptcy.

“Now, where we are seeing the market going is, in terms of portfolio management, there is much more attention now, not only to tail – which is, of course, very important for capital and for protecting really the organisation from going bankrupt – it is now becoming more and more important to look at 1-in-10 aggregate exceedance probability,” he said

Climate change is also prompting an increased demand for models suitable for ILS and cat bonds.

“We see a very large increase in the interest of using models for ILS and cat bonds,” said Savina.

This shift led to Moody’s RMS to alter its models to suit cat bond and ILS clients, resulting in niche weather models with multi-year outlooks.

“Take Europe as an example, where now we have a full coverage, in terms of modelling across seven perils: hail, straight-line wind, tornado, pluvial flood, river flood and tropical cyclone surge, and we see that those models – which we call ‘high-definition models’ – are now put at use also for cat bonds.

“Now, the peculiarity [with cat bonds] is that, when you need to model multi-year programs, then what happens is that it's very important to understand seasonality, understand clustering.”

Societal change leads to structural change in industry

For Paul Miller, head of catastrophe strategy at Guy Carpenter, exposure modelling not only needs to keep up with the effects of the climate emergency, but also with the changing make-up of society.

“We've got increased urbanisation, we've got inflation coming in as well. So what impact does that have on the potential exposure?”

Another example he gave for this is how property cat models need to take in the increased likelihood of homes being fitted with solar panels.

“Looking at the change in property characteristics. If we think about severe convective storm, think about the impact of solar panels on a property. Is that being recorded properly?” he questioned.

“New builds tend to be built with roofs made of solar panels, for example. If we look at the Greek flood event, you know, 48 hours of rain, causing a significant market loss and individual large losses coming out of that, such as solar panel farms,” said Miller.

The unpredictability of potential exposure, according to Miller, has led to a restructuring of the insurance industry.

“With the reinsurance market moving itself more away from those frequency-type events, those are now being retained by the insurance companies, impacting a lot of market dynamics which need to be factored into this discussion,” he said.

Miller emphasised that this “restructuring” has prompted clients to increasingly seek alternative forms of insurance.

“The year has been spent looking at alternative forms of capital relief by the clients, outside of the traditional market; be that in the alternative space, or be that by mutualisation across certain insurance companies” explained Miller, placing further emphasis on the importance of the use of models.

Watch the full discussion to hear more about how the industry is incorporating models into both balance sheet and capital protection as climate change increasingly poses more of a risk to the industry’s ability to manage portfolios sustainably.

Thank you to Lloyd’s director of portfolio risk management Kirsten Mitchell-Wallace; Maurizio Savina, vice president of product management at Moody’s RMS; and Paul Miller, head of catastrophe strategy at Guy Carpenter, for their participation.