Climate change: Long term resilience over short-term cost efficiencies

Companies should invest in long-term resilience rather than looking for short-term cost efficiencies if they are to manage the future impact of climate change. This was the advice issued by Ernst Rauch, chief climate and geo scientist, climate change solutions development, Munich Re, who spoke to Commercial Risk Europe on the sidelines of the European Captive Forum in Luxembourg. “It is about the extremes,” he says. “A small change in average temperature has a significant effect on extreme weather events, and that is what concerns risk managers and insurers.” And it is not just insurers that are affected by climate change risk, said Rauch. The increase in climate-themed regulation and political influence means that banks are increasingly concerned about the investment and business risk involved. The idea of using captives as a way for corporates to insure against climate change risk has been increasingly voiced in recent years. However, Rauch said that there will be significant challenges involved, just as there are for traditional insurers underwriting such risks. “Captives are impacted by climate change just as other risk management vehicles are. It depends on the individual captive and the risk manager and the climate-related risks they face – physical, liability or transition risks – and whether they take them seriously enough to manage them properly,” he said. The big challenge for climate risk management is quantification, said Rauch. For example, if you look at property risk, there are various drivers like inflation and property prices, but an increasingly important factor will be changes in vulnerability to physical risks as a result of climate change, predicted Rauch. The vulnerability element, or loss function, is based on how different buildings rate in terms of climate resilience. This in turn is based on the correlation between the intensity of an event and the expected damage. Applying this correlation to buildings and natural catastrophes began back in the 1980s in the US in reference to earthquakes. Now, 50 years on, these vulnerability calculations have evolved, to cover more weather-related properties like wind codes and flood protection, as well as compliance with regulatory developments like amended building codes. Regulation is another potentially concerning factor in the insurance of climate change, said Rauch. “In many countries there are discussions about the cost of building, the impact of regulation and the possibility of deregulation, which is a concern. It is always a question of balance based in the developmental goals of each country.” Insurers and reinsurers must also strike an economic balance. “For the time being, the question is more about the affordability rather than the availability of insurance,” said Rauch. “At Munich Re, we want to grow this part of the business but we can only put a risk on the balance sheet if we get the right technical premium.” Risk managers may counter that they are not sufficiently rewarded by insurers for their good practices but Rauch acknowledged that the insurance industry needs to better differentiate between differences in resilience. He also said that companies should nevertheless continue to invest in resilience because in the long term it will pay off. “In the long term, if you invest in the right land for your new factory or manufacturing plant, it will not only get you the best premium possible, it will also reduce the risk of your business being affected.” He used the example of a manufacturer of parts for the auto industry. “If your plant is flooded, you will have physical damage and may not be able to supply your clients. But if this continues to happen, the risk goes beyond the direct loss from the physical damage. You know you face the risk that you lose all your customers. That is why resilience is not just an insurance issue, it is an important business characteristic.”

Climate change: Long term resilience over short-term cost efficiencies

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