Catch my drift: how to control climate risk

The re/insurance industry needs to understand the difference between weather risk and climate risk if it is to grasp the once-in-a-generation opportunity to help the world manage the impacts of climate change, Marty Malinow, chief executive officer of Parameter Climate, said in an interview with Bermuda:Re+ILS.

Malinow launched the New York-based parametric risk transfer and climate focused underwriter in October 2020. A year later, he announced the company’s strategic partnership with Bermuda-domiciled specialty re/insurer SiriusPoint.

“If climate is what you expect and weather is what you get, then climate risk is the drift in expectation that could have real financial implications for re/insurers,” Malinow said. “Climate is always the long-term average of something, be it rainfall, temperature or wind speed, which is already a non-stationary risk before considering the potential impacts of pollution and anthropogenic activities.”

A meaningful mandate

Malinow was there at the birth of weather derivatives. He began his career in the capital markets, spending a decade as a fixed-income derivatives trader and portfolio manager before joining the Houston office of Enron, which had found insurance companies unwilling to insure the company against non-extreme weather events. In response, Enron created its own financial product—the weather derivative—that took inspiration from the energy futures markets in which it was involved.

Although this was a smart move, it initially missed the mark, Malinow said.

Enron and the three other big energy players in the weather trading space—Aquila Energy, Koch Energy Trading and Southern Company Energy Marketing—had simply found another way to trade speculatively instead of adopting a “meaningful mandate for end-user risk transfer”, he said.

“The focus should have been building a risk management market where you could warehouse customised end-user risks as opposed to trading standardised dealer risks,” he explained.

After leaving Enron in 2000, Malinow co-founded XL Weather & Energy and headed its global weather business before co-founding Galileo Weather Risk Management in partnership with White Mountains Insurance Group in 2005.

Malinow and the management team bought Galileo from White Mountains in 2009 before Endurance Specialty Holdings acquired the assets of Galileo in 2012 and appointed Malinow as president of Endurance Global Weather, which was re-badged as Sompo Global Weather after Sompo’s acquisition of Endurance in 2017.

“I’ve always been an entrepreneur and I saw another opportunity forming in the parametric market, one that required an end-to-end approach which wouldn’t fit neatly into a carrier, broker or modelling firm model,” he said. “It had to be a startup across the street.”

The answer was Parameter Climate and, with lineage to White Mountains, SiriusPoint was the obvious candidate to become its minority investor.

“I had maintained a close relationship with Steve Fass, the former CEO of White Mountains, who was vice chairman of SiriusPoint when we were raising capital, so we began talking. It turned out that there were a lot of people I already knew at SiriusPoint, so there was a high level of trust and a culture we valued.

“SiriusPoint had embarked on a new business model of creating strategic partnerships, which provided the capital we needed to scale up our team and build our proprietary analytics, but they also offered risk capacity and paper, which meant we could begin to write business straight away,” he said.

“Because we’d been able to get out of the blocks pretty fast, we hit a significant milestone in revenues within six months.”

Parameter is “seriously considering” forming a subsidiary in Bermuda thanks to the Island’s unique market regulatory environment, he added.

Insurable and investable

Malinow’s “bumper sticker” message on how he will measure success at Parameter is the extent to which it makes parametric climate risk “insurable for the buyer and investable for the seller”. This will happen only if there is consistency and transparency of underwriting information and price discovery.

“You can’t have one person reading the Old Testament, another reading the New Testament, and another reading the Bhagavad Gita, and then trying to agree on a price. There has to be a placement mechanism that is very open and looks a lot more like the insurance industry than the weather market has for the past 20 years,” he said.

Parametrics are not an outlier innovation, he said, but rather the “other side of the insurance coin” from indemnity protection.

“A rate-limiting factor in the parametric market has been the time it takes to structure and place a product,” Malinow explained.

“Clients have died of old age before deals have ever got into place,” he joked. “At Parameter Climate, we combine risk modelling and product structuring with real-time and iterative pricing, so there are no surprises when our clients go to the market.”

What makes his company different from other advisors, he said, is that it is prepared to assume risk and, if necessary, “find the right home” for risk through its distribution partners.

Parameter services its clients for “the full life cycle” of their transaction, he added.

“We provide the analytics, modelling, products, programmes and services so that people can turn that uncertainty into a risk to allow the insured and the insurer to work on mitigation in a manner where they can become more responsible in the management of their assets as it relates to global climate,” Malinow said.

Another way of thinking about the financial impact of climate risk is the cost of renewals 10 or 20 years from now because there’s a “drift” to the risks to which the insured is exposed.

“A farmer might think of mean rainfall as a 10-year average, but what will the 10-year average be 10 years from now? If you’re an insurance company, and you want your relationship with your client to be meaningful, then you have to be able to ask what they are doing, not between now and the contract renewal next year, but between now and the next 10 to 20 years,” he said.

“Addressing climate risk doesn’t start with the capital, the brokers or the reinsurers; it has to start at the front, between the insured and insurer. If an insurer simply sells a series of annual products over a 10-year period, they are not really addressing climate risk, but simply pushing this back onto the insured.

“You need to structure the long-term risk of climate change into an insurable product and in an investible way, and we believe that the capital market is likely a more efficient long-term climate risk warehouse than the balance sheets of insurance or reinsurance companies.”

In order to increase its relevance in an evolving regulatory landscape and represent a broader range of market participants with an expanded mandate, Malinow believes that the Weather Risk Management Association, of which he is a former president, should change its name to the Climate Risk Management Association.