Physical risks posed by climate change could potentially affect three areas of our business:
- Reduction/disruption of our own operations
- Modelling and pricing of weather-related natural perils
- Impact on the economic viability of re/insurance for risks exposed to extreme weather events
Our own operations
According to our in-house catastrophe loss models, severe weather risks are potentially of importance for some of our operations, mainly in Florida and on the northeastern coast of the US. However, even assuming an extreme climate change scenario, we do not expect any of these locations to be exposed to risk levels that would question their economic viability. In 2012, Hurricane Sandy in New York showed that some of Swiss Re’s offices are already exposed to severe weather risks today. In response, we have sharpened the Group’s business continuity management to minimise property losses and business interruption. Thanks to these investments, we are able to swiftly transfer work tasks to unaffected areas if required and to keep potential financial impacts minimal.
Modelling and pricing of weather-related perils
Based on our proprietary loss modelling, we calculate the annual expected losses (AEL) of the major weather-related natural catastrophes; the four perils with the largest AEL at present are disclosed in the TCFD Metrics and targets section (North Atlantic hurricane, US tornado, European windstorm, Japanese tropical cyclone). Our models show that with the current climate, the dominant factor is natural variability affecting both the frequency and severity of extreme weather events in all regions. We expect this to remain the case both in the short and medium term (ie 2025 and 2030), in line with the latest scientific findings (see the IPCC Fifth Assessment Report, chapter 11).
In addition, we expect weather risk to remain assessable by scientific methods, meaning we can continue to update our loss models in the future to assure adequate costing of extreme weather events. Since most of the re/insurance contracts with our clients have a duration of one year, we can thus adequately price natural catastrophe risks by updating our models to reflect the current climate.
Regarding the long-term time horizon (2040), we expect a substantial need to adjust some of our weather risk models, based on current scientific knowledge. We are confident, however, that future research will give us sufficient guidance on the magnitude and direction of these adjustments.
Impact on the economic viability of re/insurance protection
An increase in the frequency and severity of extreme weather events can restrict the affordability of re/insurance in certain regions, especially in coastal areas, by requiring a rise in premiums. While climate projections are associated with a large range of uncertainty, especially when it comes to storms making landfall, increases in the frequency and severity of tropical storms are likely. Natural variability is expected to remain the dominant factor in the short and medium time horizon (2025 and 2030). In the longer term (2040), though, sea level rise will lead to non-linear increases in the storm surge risk for coastal areas. Additionally, warmer temperatures will lead to more extreme rainfall events that may increase flood risk.
If rises in re/insurance premiums necessitated by increasing extreme weather risks remain modest, ie re/insurance protection remains economically viable for our clients, the overall premium volume will actually grow. Larger increases, however, will reverse this effect eventually by pushing re/insurance prices for certain exposed risks beyond the limits of economic viability. This is particularly relevant for areas with inadequate construction planning and development. In addition, timing is also of crucial importance: if measures to exclude a particular risk are taken too early and without broader market support, we can offer our clients less insurance protection and may lose significant market share; if measures are taken too late, we may end up with increased loss potential.
In line with independent external studies, we have shown through a series of scenario assessments (Economics of Climate Adaptation studies, ECA) that in many regions, climate adaptation measures need to be taken to limit expected increases in natural catastrophe damages and thus to ensure the economic viability of re/insurance in the future. This is a key reason why Swiss Re actively engages with the United Nations, the public sector, clients, industry peers and employees to advocate cost-effective adaptation to climate change.
Conclusion: Although the physical risks arising from climate change will have significant economic consequences over time, especially from a wider societal perspective, they represent a limited and manageable risk for Swiss Re.
Transition risks in our re/insurance business
“Transition risks” may arise as a result of the extensive policy, legal, technology and market changes that are required to make the transition to a low-carbon economy. We have carefully assessed the two transition risks that may potentially affect our business:
- Climate-related litigation risks
- Risks from technological and market shifts
Climate-related litigation risks
We first assessed potential climate-related litigation risks several years ago through our own research. Our latest round of monitoring has shown that litigation activities against large greenhouse gas emitters and associated insurance coverage disputes have in fact declined substantially in recent years and that there have been very few shareholder class actions.
As a result, Swiss Re has not faced any claims from climate-related litigations in recent years and the results of the litigations, which were in favour of the defendants, suggest that this trend is likely to continue.
Technological and market shifts
The re/insurance sector is likely to experience the technological transition in two ways. Firstly, new technologies by definition do not have loss histories and thus may be challenging to cost accurately. Thus, research and development is required to develop possible loss scenarios and the related expenses. Once these are developed and tested, though, new technologies are likely to present the sector with an opportunity to offer new solutions (see “Climate-related opportunities”, above).
Secondly, the new green energy technologies are likely to gradually displace traditional, fossil-based ones. This will alter the energy market and, as a result, gradually change the nature of re/insured assets.
This transition does not automatically translate into a financial risk for Swiss Re, though. To illustrate, motor insurance is the most important business line of the re/insurance sector, globally: According to a recent study, it currently represents 42% of all non-life gross premium of the total property and casualty insurance market and is expected to grow by a further 6.8% until 2026.1
Driven by intensifying efforts to curb climate change, the global vehicle inventory will shift from combustion to electric engines. However, this change is expected to be gradual. As motor insurance contracts are renewed annually, re/insurers will thus be able to develop the appropriate underwriting experience, loss adjustment and claims handling.
To address the residual risk, we have recently started to develop a carbon risk steering mechanism. Its key component will be a carbon risk model designed to measure our carbon intensity and associated risks embedded in our re/insurance business.
The initial part of this carbon risk steering mechanism will take the form of a thermal coal policy, to be integrated in our Sustainability Risk Framework by mid-2018. It will apply across all lines of business on the direct, facultative and treaty sides. This transition will take some time and constructive dialogue with our clients.
Conclusion: Overall, the transition to a low-carbon economy does not present a significant financial risk for Swiss Re. Mainly due to the annual renewal of contracts, the associated risks can be managed effectively.
Transition risks in our investments
Climate-related risks can also impact the value of our investments. A key risk for asset owners is that a changing environment for a particular company or industry sector may lead to stranded assets in investment portfolios, eg the devaluation of investments due to unfavourable changes, such as statutory requirements or taxes. With regard to climate change, the market environment could shift to address mitigation and adaptation requirements related to achieve a 2°C world.
In the current disclosures, we focus on “policy and legal” as well as “technology” risks as we mainly expect developments and changes within these two dimensions that impact the asset values. In this way, we aim to capture those industries and groups of companies that are most exposed to these risks in a positive or negative way and may therefore require adjustments in the near term.
Industries and companies that are particularly exposed to changes in policy and legal as well as technological developments show elevated risk exposures either in the production process, in raw materials, in transportation/logistics or distribution and store operations due to high carbon footprints in these areas. Furthermore, the industries and companies may face increased costs due to higher or more volatile energy prices, compliance costs in the production and distribution process, and cost from product demand substitution. All these changes may cause increased price volatility of the underlying assets.
Based on Swiss Re’s commitment to support the transition to a low-carbon environment, we started to measure the weighted average carbon intensity1 of our listed equities and credit portfolio from the end of 2015. Measurement results are presented in the “Metrics and targets” section. The assessment of the portfolio coincided with the decision to stop investing in companies that generate 30% or more of their revenues from thermal coal mining or that use at least 30% thermal coal for power generation. Furthermore, we divested from all related equity positions and the vast majority of our fixed income holdings.
1 The future of motor insurance, a joint whitepaper by HERE and Swiss Re, 2016.
2 Weighted average carbon intensity = (company CO2/company revenue) * (investment/portfolio)