EDITOR’S LETTER

Missing: one crystal ball (no previous owners)

So here we are: midway through the renewals season again. Third quarter earnings calls have taken place indicating a surprisingly mixed bag of profits in the face of the adversity caused by cat losses. The industry is surprisingly bullish, enjoying the fruits of a hard market while it lasts—despite rising costs in the form of social inflation and climate change.

Ah, climate change. The topic that the industry has been talking about for decades. Yet suddenly its implications—and its consequences—seem so real.

Across the conferences that have taken place recently, from Baden-Baden to Denver, mixing virtual technology with face-to-face meetings, all conversations have quickly turned to the subject of climate change—and especially to what extent the greater frequency and severity of certain cat events is being caused by this.

This is not necessarily because of the scale of the recent losses themselves, although they were exceptional. 2021 could well rival 2020 for insured losses, a year that broke many records, with US insurers alone paying out $74 billion in insured losses.

No, the focus on the losses is more because their nature keeps surprising the industry—sort of. So-called secondary perils, including wildfires and floods, continue to increase in frequency and severity, and there is a growing awareness that the tools the industry uses to understand these are inadequate.

Pricing in the spotlight

But even the main, and apparently expected, perils such as hurricanes are behaving in unusual ways, triggering losses from unexpected sources. This is an industry that dislikes surprises—and it has no crystal ball.

The industry is starting to realise that it is coping with an increasing number of unpleasant surprises. The risk models suddenly appear inadequate. And the spectre of climate change lurks over all of this.

All these factors have put the pricing of catastrophe business and climate change in focus. The frequency and severity of everything from flooding to hail to winter freezes to convective storms to droughts to wildfires are now under the microscope. The fear in the industry is that risk models, which lean heavily on historic data, are no longer adequate for pricing risk.

This is a game-changer for the industry. Underwriting has always profoundly relied on analysing historic information. The better the data, the more informed the underwriter—and the more accurate the pricing. That has been a fundamental of the industry since its foundations.

That points to a major change that is needed in the industry. It is no use celebrating a hardening market if the underlying risk profile is changing faster. Many fear that for some risks, regardless of higher rates, the premiums are insufficient due to these perils being misjudged and underestimated in the context of climate change.

The reality now, is that the industry needs to implement price adjustments to accommodate the impact of climate change on those secondary perils.

The industry is clearly entering a new era in the way it assesses and considers risk. For the first time in its history, and perhaps largely due to climate change, it may need to consider the future as much as the past when making big decisions.