Multinational businesses will need to place increasing emphasis on reviewing pre-loss and post-loss risk management in order to mitigate the impact of increasing losses from weather-related catastrophes, driven in part by climate change, risk managers heard at an AGCS briefing on the financial impact of such events.
Volatile weather activity is increasing, as demonstrated by the unusual number of extreme events that characterized the beginning of 2014. There were heatwaves in Australia and perhaps, more surprisingly Slovenia. Meanwhile, Vietnam experienced snow while North America witnessed the return of the polar vortex. In the UK the population experienced its wettest winter in 250 years at the same time as the southern hemisphere had the warmest start to a year ever recorded, with Brazilian and southern African cities particularly impacted.
The impact of an upturn in extreme weather activity is felt keenly on the balance sheet. According to Allianz between 1980 and 1989 $15bn a year was paid out for extreme weather events by insurers. Between 2010 and 2013 this figure rose to $70bn a year on average.
Meanwhile, insured losses from weather events as a proportion of global GDP increased by 327% between 1974-1983 and 2004-2013 from 0.018% to 0.077%.
Changes in the climate and weather patterns have the potential to affect extreme weather events around the world in three primary ways – more intense windstorms, incidences of heavy rainfall leading to flooding events and increasingly severe drought episodes.
In future the loss potential for global businesses from such events will be exacerbated by additional risk factors such as rapid urbanization – and the failure of development of sufficient infrastructure to keep pace with this – and the greater interconnectedness of the global economy, resulting in increasing business interruption (BI), contingent business interruption (CBI) and supply chain exposures, risk managers from some of the UK’s leading companies heard at a recent briefing on the financial impact of weather events, hosted by AGCS in London.
Dr Rebecca Mitchell, Head of Emerging Markets, UK Met Office, Charles Whitmore, Managing Director and Head of Property Solutions Group, EMEA at reinsurance broker Guy Carpenter, Martin Henson, Regional Head of Claims, AGCS, Clive Trencher, Senior Risk Consultant, AGCS and Dan Tomlinson, Managing Director at Allianz Risk Transfer all gave presentations to risk managers from a number of FTSE 100 institutions at the weather risk event.
And the key takeaway from the briefing was clear. If natural catastrophe risk management procedures are not in place or have not been regularly reviewed, the magnitude of such losses can increase significantly.
Climate change “unequivocal”
Climate change is unequivocal, Dr Mitchell told risk managers at the briefing, adding that it is leading to more extreme weather patterns. Natural variability also has an impact, both on short duration events such as windstorms, and long duration events such as prolonged rainfall. In the UK, for example, Dr Mitchell noted that – prior to 2014 – four of the last six summers have been amongst the wettest 10 since 1910.
Meanwhile across Europe it is anticipated that the changing climate will mean that a very hot summer such as 2003, which was the hottest on record in Europe for more than four centuries, could become the norm by the 2040s and be classified as a cool summer by the 2060s.
“How we go about adapting as a society to these sorts of potential futures is something we will need to consider and it is also something businesses will need to consider over shorter and longer timeframes,” Dr Mitchell said.
“Even with a one degree change in temperature we are already into a position of an increased level of risk of more extreme weather events such as heatwaves, droughts and floods.”
More severe flood events
Eight of the 10 largest historical flood losses have occurred in the past 13 years causing over $100bn in economic damages.
And the trend of the impact of flood events becoming more severe will be further exacerbated by the significant level of urbanization that is predicted to occur in the future.
By 2050 it is estimated that 68% of the global population will be living in cities, many of which are located in highrisk coastal areas. Level of investment in infrastructure is unlikely to keep pace with this rapid pace of urbanization, potentially impacting coastal defenses, building codes and disaster preparedness.
By 2070 it is projected that all but two of the top 10 global cities ranked by assets exposure to coastal flooding will be in Asia, including four in China alone (see map). Six years ago the top 10 list was comprised of cities in the US, Netherlands and Japan.
China has the biggest flood loss potential for industrial parks with 52% at risk of river flooding and 25% threatened by storm surge. The Pearl River Delta alone
has higher loss potential than all of Thailand, which in 2011 experienced the largest flood loss in history – costing approximately $50bn in economic damages and over $16bn in insured losses, a significant proportion of which were attributed to BI and CBI losses stemming from thousands of factories owned by multinational companies being inundated.
More severe BI implications
The greater interconnectedness of the global economy is manifesting itself in increasingly more complex production processes with higher economic values. The end result is more severe BI implications.
Analysis of over 11,000 major business insurance claims in excess of $136,000 (€100,000) involving AGCS - as detailed in its recently published inaugural Global Claims Review 2014 – shows that at $1.36m (€997,602) the average BI claim is 32% higher than the average direct property damage claim ($1.02m/€755,198).
In addition, adequate coverage of CBI and supply chain risk exposures remains a gap in many multinationals’ insurance programs.
“The scale of the CBI losses in Thailand took many companies by surprise,” said
AGCS Regional Head of Claims, Martin Henson. “Companies still need to spend more time examining their potential CBI/supply chain risk exposure. They put a
lot of time into assessing direct damage and looking at their own BI impact but
probably not as much as they should do in terms of the risks associated with supplies and customers.”
Interdependencies between suppliers is often a big unknown and it is estimated that only 50% of businesses have alternate suppliers, according to AGCS.
Such losses also highlights the need for more research and resource to be committed to better understanding flood risk, for which there are currently fewer modeling solutions available compared with other natural catastrophe perils.
“Having a flood plan in place – which is a properly documented series of actions – is absolutely vital in the event of a potential flood happening. Flood mitigation can be the difference between a company suffering a serious loss and a catastrophic one,” said Clive Trencher, Senior Risk Consultant, AGCS.
Death by a thousand cuts
While such extreme weather events continue to capture the headlines, Allianz Risk Transfer Managing Director, Dan Tomlinson also explained during the briefing how minor fluctuations in expected weather can have a big impact on the financial performances of businesses across a wide range of industries.
“A change in expected temperature over the course of one day is not going to change anyone’s bottom line,” he said. “However, a change in expected temperature that lasts day in day out over a whole winter heating season or indeed a whole year will have a cumulative effect on revenue. It is a death by a thousand cuts scenario – a company’s revenue can be eroded over time.”
The economic impact of increasing everyday weather volatility far exceeds the already huge sums annually associated with natural catastrophes. AGCS estimates that the impact of routine weather variation on the European Union’s economy could total as much as $524bn (€406bn) a year. As a comparison, during 2013 the global natural catastrophe loss bill including all weather-related events totaled approximately $125bn.
There is now an increasing awareness and interest in weather risk management tools, which offer a new avenue for companies to create customized responses to the specific weather variables which can affect their business. Using independent weather data, these products are linked to actual fluctuations against pre-agreed weather indices which, when certain criteria are met, can trigger a payment, enabling companies to hedge this risk, similar to the way they might do with interest rate movements and foreign currency exchange rates.
Regional Head of Claims, AGCS
Managing Director, Allianz Risk Transfer
Senior Risk Consultant, AGCS