Insurance solutions for environmental risks ? Philippe TRAINAR Chief Economist Officer SCOR 35 th...

Insurance solutions for environmental risks ?

Philippe TRAINARChief Economist Officer SCOR

35th OAA Conference and General Assembly24th – 29th May 2008


Specificities of environmental risks ?

Whither insurance solutions ?

Role of government vs insurance ?


Specificities of environmental risks ?

1. Environmental risks : six key facts

2. Environmental risks and climate change



1. Human being is fighting against natural catastrophes at the same time

when it is “cooperating” with nature ; human organizations have been built for protecting their members against these perils which

2. Nature is destroying human productions and human beings : losses (financial costs as well as deaths etc.) due to natural catastrophes make three fourth of all the losses due to catastrophes, either natural or technological and human

3. Nature is killing less than in the past : it’s a consequence of rising efforts of protection and prevention,

4. But, catastrophes are occurring more often and affecting a rising number of people as a consequence of : rising world population Concentration of world population on the most risky areas around the world

5. The share of climatic catastrophes increases rapidly, in term of nulbers as well as of costs

6. Floods dominate in term of frequency and Storms in term of costs among climatic catastrophes


Graph :Importance of environmental catastrophes

Source : EM-DAT, University of Louvain

US$billions



Human being is fighting against natural catastrophes at the same time


Nature is destroying human productions and human beings : losses (financial costs as well as deaths etc.) due to natural catastrophes make three fourth of all the losses due to catastrophes, either natural or technological and human

Nature is killing less than in the past : it’s a consequence of rising efforts of protection and prevention,

But, catastrophes are occurring more often and affecting a rising number of people as a consequence of : rising world population Concentration of world population on the most risky areas around the world

The share of climatic catastrophes increases rapidly, in term of nulbers as well as of costs

Floods dominate in term of frequency and Storms in term of costs among climatic catastrophes


Graphique 4 :La population se concentre dans les zones à haut risque

Source: United Nations Population Fund: State of World Population 2007 www.unfpa.org


Graph :Number of natural catastrophes around the world


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cats nats non climatiquescats nats climatiques




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inondationstempêtes


2. Environmental risks and climate changeAvailable (re)insurance data don’t give us a good idea of the climate change that is taking place, for two main reasons :

Consequences of climate change are ambiguous : for ex., hurricanes will decrease in number, increase in average intensity, remain stable in maximal intensity

The most significant consequences of climate change are coming but not yet observable : temperature has not sufficiently increased for significant consequences

For a good climate strategy, it is as much important, to implement active prevention policies aimed at reducing the exposure of the world population to climatic catastrophes than to reduce carbon use :

Even if the world is reducing quickly carbon use, it will be confronted with increasing climatic catastrophes in the coming years because trends are difficult to alter

Moreover, one main source of increasing carbon use, i.e. population and economic growth, will not come to a standstill in the coming years

If the trend toward increasing concentration of world population in the most dangerous areas is not reversed, major catastrophes can be anticipated

These risks would be all the more serious because they would induce pandemics and migrations that may degenerate in armed conflicts for water, foods etc.


Graph :Hurricanes and climate change

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Graph :Increase of temperature and climate risks

Source : Rapport Stern


Whither insurance solutions ?

1. Pb : ambiguous & potentially systemic risks

2. An active & rapidly developing market offer


1. Pb : ambiguous & potentially systemic risksEconomic nature of environmental risks

Extreme and progressive risks– Extreme risks : combination of low probability and high severity– Progressive risks : climate change risks are emerging over the long term

Risks for which it is difficult to find willing counterparties– Uncertain definition and frontiers of environmental risks : risk of ambiguity– In most extreme cases, everyone is affected : uninsurability of systemic risk

Risk for which capacities are limited– Underestimation of extreme risks by insured => non willingness to pay– Limited available capacities for potentially unlimited risks => fluctuating price

Concerned insurance Lines of Business Mostly property insurance : material destructions by flooding and wind :

– Houses and cars– Professional buildings and equipments

Threatening liability insurance : legal actions against :– Negligent executives, directors and authorities– Responsibility of carbon producer (climate change)

Emerging life insurance : human destruction by flooding and wind– Mortality risks– Disability risks


Graph :Uninsurability of climate change

Source : Stern report


1. Risks that are potentially ambiguous & systemicEconomic nature of environmental risks


Risks for which it is difficult to find willing counterparties– Uncertain definition and frontiers of environmental risks : risk of ambiguity– In most extreme cases, everyone potentially affected : systemic risk

Risk for which capacities are limited– Underestimation of extreme risks by insured => non willingness to pay– Limited available capacities for potentially unlimited risks => fluctuating price






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= t

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Detrended Cat insurance premiums

Source : Lane Financial LLC

AndrewKatrina

WTC


1. Risks that are potentially ambiguous & systemicEconomic nature of environmental risks


Risks for which it is difficult to find willing counterparties– Uncertain definition and frontiers of environmental risks : risk of ambiguity– In most extreme cases, everyone potentially affected : systemic risk

Risk for which capacities are limited– Underestimation of extreme risks by insured => non willingness to pay– Limited available capacities facing potentially unlimited risks => fluctuating price






Graph :Number of victims of natural catastrophes

Source : SwissRe, Sigma 2/2007

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2. An active and rapidly developing market offerComponents of insurance contracts covering environmental risks

Three classical available instruments :– Explicit limits to indemnities : they make all environmental risks insurable– Explicit excesses : they limit the huge moral hazard of environmental risks– Explicit modulation of premiums with regard to the risk exposure : it limits anti-

selection, which is prevalent with environmental risks Necessity to combine the three instruments in a sophisticated manner

Insurance to be complemented by reinsurance The value added by reinsurance to insurance of environmental risks :

– Complementary capacities from more risk tolerant shareholders– Enlarged international pooling for risks whose national pooling is limited– Top expertise on environmental risks (cf. reinsurance models)

A structuring actor for insurance pricing(Re)insurance to be complemented by securitization

The value added by securitization :– Revelation of pooling dimension not available on the (re)insurance market– Correction of the (re)insurance coverage biases against extreme risks

A complement of reinsurance more than insurance– Optimal pooling of reinsured risks vs insured risks– Because of structuration costs, direct securitization reserved to big insurers


Graph :ILS issued and outstanding

Source : SwissRe, Sigma 2/2007

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Outstanding from prev. years

New issues


Role of government vs insurance ?

1. Role of governments around the world

2. Bad and good reasons to intervene


1. Role of governments around the worldIn most countries, natural catastrophes are insured by market insurance (storms, floods, volcanoes, earthquakes, droughts)Nevertheless, in some countries, government are used to intervene :

In most cases, for organizing the guarantee of a specific national risk :– Floods in USA– Earthquakes in California, Japan, New Zeeland, Taiwan, Turkey– Storms in Florida

More seldom, for organizing the guarantee of all natural catastrophes :– Iceland, Norwegian, Spain, Switzerland, France

Except in France (for households and companies) and in Japan (for households only), the guarantee is supplied by the (re)insurance market (often in the framework of a pool) France is the only industrialized country where the government intervene directly, by mean of a dedicated public reinsurance company, despite no specific national risk ; characteristics of this public regime are :

An unlimited government guarantee for households and companies Conditioned by a 50% quota-share with the public reinsurance company Inducing a huge moral hazard : most houses are now built in flooding areas Organizing a huge transfer and subsidy system in favor of small subset of insured


Graph :Concentrated and recurring compensations in France

Source : FFSA, 2007

Lecture : 75 % of the areas have a probability of compensation lower than the average 1,3 ‰when 4 % of the areas have a probability larger than 4 times this average

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2. Bad and good reasons to interveneThree bad reasons for public intervention

Uninsurability of cat risks– Of course, most dangerous environmental risks are cat risks– Nevertheless, for most cat risk capacities are available and increasing

Equality between inured, independently from their risk exposure– Of course, risk exposures are not always chosen – Nevertheless, not penalizing risky choices increases risk taking (moral hazard)

Short term concerns of market forces – Market does not give the right incentive for long term prevention (cf. carbon use)– In fact, government is more short term oriented than market forces

Why and whither public intervention ? Three good reasons for public intervention

– Blindness of consumers, who underestimate extreme risks, esp. at long term– Limitations and fluctuations of (re)insurance capacities – Systemic dimension included in all the environmental risks– Need for governments to have an incentive to invest in public equipment

Need for a public / private partnership based on :– GAREAT and TRIA philosophy : market is in charge of non systemic losses– Public guarantee given at market price for loans issued for covering excess loss– Objective assessment of risk exposures and losses


Graph :Increasing reinsurance capacities

Capital issues by reinsurers

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2. Good and bad reasons to interveneThree bad reasons for public intervention

Uninsurability of cat risks– Of course, most dangerous environmental risks are cat risks– Nevertheless, for most cat risk capacities are available and increasing

Equality between inured independently from their risk exposure– Of course, risk exposures are not always chosen (cf. inherited house etc.)– Nevertheless, not penalizing risky choices increases risk taking (moral hazard)

Short term concerns of market forces – Market does not give the right incentive for long term prevention (cf. carbon use)– In fact, government is more short term oriented than market forces

Why and whither public intervention ? Three good reasons for public intervention

– Blindness of consumers, who underestimate extreme risks, esp. at long term– Systemic dimension included in all the environmental risks– Limitations and fluctuations of (re)insurance capacities – Need for governments to have an incentive to invest in public equipment

Need for a public / private partnership based on :– GAREAT and TRIA philosophy : market is in charge of non systemic losses– Public guarantee given at market price for loans issued for covering excess loss– Objective assessment of risk exposures and losses


Graph :A pool mode of senior and junior slices

Losses’frequency

Losses

Slicefinanced

by insurers

Slice financed by re-insurance and by

big insurers

Slice financed by issuing a corporate bond guaranteed by the government

Slice financed by reinsurance


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CONCLUSION

Environmental risks are more and more affecting the daily life of the world currently and this trend will not reverse in the coming years

Environmental risks have the potential to become catastrophic and climate change presents a threat for the world from this point of view

Insurance markets is able to cover the environmental risks, even when extrem, except when they become systemic at national level

Reinsurance and securitization markets are able to offer a complementary cover for environmental risks, even when extrem, except when they become systemic at international level

Government intervention should concentrate on systemic risks and avoid to induce too much moral hazard or anti-selection

This handling of such a situation requires a public / private partnership based on the complementarities between the different actors :

insurance insurance reinsurance reinsurance securitization securitization government intervention government intervention

ANNEXE

Cercle “La part de risque”2 avril 2008

Insurance solutions for environmental risks ? Philippe TRAINAR Chief Economist Officer SCOR 35 th...

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