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Reinsurers under-estimating climate risk by as much as 50%: S&P

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S&P Global Ratings says reinsurers globally have probably underestimated their exposure to physical climate risk by 33-50% despite increased efforts to price in the impact of extreme weather events.

Many are facing difficulties in implementing climate change considerations robustly, according to the rating agency.

“If re/insurers are not properly accounting for the impact of climate change… it could lead to significant unexpected volatility in their earnings and capital, resulting in pricing corrections that could have implications for the cost of reinsurance purchased by primary writers, thereby hitting their profitability and risk profiles as well,” S&P said.

The rating agency says its empirical scenario highlights that for the more recurrent extreme weather events, typically below the one-in-50-year return period, there is a risk that exposure might be under-calculated.

And for return periods beyond the one-in-50-year mark, there is no data point in recent history, making it difficult to quantify potential under-estimation.

“Nonetheless, we believe that under our scenario, very extreme losses such as a one-in-200 or one-in-250-year event would likely be underestimated, and we have assumed a shift of the risk of a similar magnitude,” S&P said.

“Earnings and capital volatility of global reinsurers would undoubtedly be increased under our empirical scenario.”

S&P says the scenario’s results point to a material increase in the amount of capital re/insurers will need to hold for their catastrophe exposures, that is, the one-in-250 catastrophe charge in its risk-based capital model, to the tune of $US21.7 billion ($29.8 billion) in aggregate for the industry.

In addition, the modelled exposure to a one-in-10-year event for the industry would increase by at least $US7.4 billion ($10.2 billion) in aggregate.

“In order to offset the additional capital burden and increase in expected losses, re/insurers would likely have to increase the premium rates they charge for natural catastrophe business,” S&P said.

“However, in our view, the industry’s ability to reprice for the risk of climate change may not be sufficient or responsive enough, particularly in a largely commoditised market with differing viewpoints on the adequacy of pricing for physical climate risks.”