Climate change: Bermuda re/insurers are leading the way

17-09-2020

Climate change: Bermuda re/insurers are leading the way

Andy Macfarlane AXA XL

Next to the impact of COVID-19, climate change is arguably the fastest-growing concern for the re/insurance industry. Andy MacFarlane of AXA XL discusses re/insurers’ top concerns and innovative ways to address the risks with Bermuda:Re+ILS.

While the re/insurance industry works to address the issues raised by COVID-19, another global risk rumbles on in the background. Climate change is not about to go away, and as the world races to find ways to create resilience to exposed communities, the Bermudian re/insurance industry is very much at the heart of the action.

Andy MacFarlane, leader of AXA XL’s public sector partnership working group, says this is because Bermuda is such an important player in the property catastrophe space through the capacity that traditional markets bring—it has shown how innovative alternative capital use can be part of the solution.

“We cannot focus on one aspect of the risk function—all aspects need to be considered and understood when thinking about this complicated topic.”

As more models are created to tap into other regions and perils, he expects the involvement of alternative capital to increase.

“Bermuda’s capacity to deal with the risks associated with a changing climate is a key selling point for the Island,” MacFarlane says.

“There is innovation around insurance-linked securities and how to attract that capacity into the market, and there’s a lot of talk about closing the protection gap and working with governments to figure out ways in which they can transfer risk.

“A key question now is whether parametric insurance is becoming a bigger part of the equation, and if so, how does the Bermuda Monetary Authority as the regulator enable the market to position itself to take advantage of that as it grows?” 

Closing the gap

AXA XL is focused on bringing solutions to the protection gap problem through all avenues, with parametric insurance one of those being provided through the AXA Climate Team.

AXA XL and AXA Climate are looking at ways to bring capacity into the areas where insurance penetration is low while demonstrating to governments the value that insurance can bring to their communities through parametric or traditional reinsurance.

“The question is: how do you create the market to allow governments to readily access all forms of cover to provide that protection?” says MacFarlane.

“Parametric insurance is one of the solutions and is growing in popularity in terms of being able to do that, because of the ease of the calculation.”

MacFarlane highlights the issue of basis risk in parametric insurance. The index/measurement relied on as a trigger doesn’t necessarily track the risk perfectly, he says.

“Over time this is becoming less of an issue because the access to data we get is improving along with our understanding of deficiencies within the calculation of the index,” he explains.

Despite that, it remains crucial to understand where these deficiencies might exist relative to the hazard you are trying to cover, he adds.

“Triggers have to be well designed, well defined and able to be accurately measured.” 

Know your risk

For MacFarlane, understanding vulnerability is one of the three key elements for any successful discussion about understanding insurance risk related to climate change. The other two are an understanding of the hazards (for example, cyclones, storms and droughts), and the exposures (the assets that are at risk).

“We cannot focus on one aspect of the risk function—all aspects need to be considered and understood when thinking about this complicated topic,” he says.  

A further issue is understanding the effects of the accumulation of greenhouse gases in the atmosphere and how these will be felt far into the future.

“The challenge for us as industry is to think about how that relates in the near term, versus what the science is saying in the long term—balancing that problem is very tricky,” says MacFarlane.

There may be some areas where certain hazards are improving.

Modelling the risks associated with a changing climate is a vital tool in the re/insurance industry’s response. It has the potential to open up markets in geographical areas that have not previously been covered.

AXA XL is a contributing member of the Insurance Development Forum (IDF), working as part of a broader team thinking about ways to model these risks and make the models publicly available, thereby bringing an understanding to the risk that exists and then allowing capital to be placed to match that risk.

“Risk is changing and it’s important to consider that it is not a one-way narrative,” says MacFarlane.

“Hazards are changing, in some instances there are signals that certain hazards are getting worse, but there may be some areas where certain hazards are improving.”

He adds: "When it comes to ocean levels, for example, most areas are showing rising sea levels, but there are also areas being affected by rising land masses where sea levels are falling."

AXA XL has been involved in a range of ocean research projects. In 2017, AXA XL launched its Ocean Risk Initiative which has three key areas of focus: to drive the insurance industry’s response to ocean risk, catalyse product innovations, and increase ocean literacy.

Through the Ocean Risk and Resilience Action Alliance, an outcome of the first Ocean Risk Summit held in Bermuda in 2018, AXA XL is leading the development of an Ocean Risk Index.

The index is a bespoke model looking to understand the economic impact of physical risks from the ocean on exposed communities. The index will initially focus on sea level rise and include impacts of changing sea levels on coastal communities for different return periods.

“Once you are able to map it, that information would be useful in terms of understanding not only the risk but also the potential in terms of structuring future products to provide resilience to these exposed communities,” says MacFarlane.

He believes the index will play a key role as talk about the value of the “blue economy”—the value the oceans bring to the economy—increases, along with awareness of the way oceans are changing and impacting human life at a time when more of the population is moving to the coast. When thinking about risk, this population change is an indicator of changing exposure. 

Natural assets

A related area of focus for AXA XL is mangrove forests. These multifaceted natural assets protect communities against the impact of storms and sea level rises, act as sequesters of carbon and can provide livelihoods for communities, for example by supporting fish stocks.

“We are trying to quantify the impact that mangroves have and are exploring how to protect and insure mangroves,” says MacFarlane.

“An ideal scenario would be to partner with a cedant that has a big coastal footprint including mangroves and encourage them to see the benefits the mangroves would bring to their portfolio through providing resilience, along with being able to offset their carbon footprint through the carbon that the mangroves sequester.”

He adds that investment in mangroves could be incentivised with tax credits for carbon-offsetting and by rewarding resilient post-event redevelopment.

Changing people’s mindsets is an important part of any future work around climate risk. As the re/insurance industry seeks to improve and increase coverage in this field, MacFarlane sees great potential for educating communities, businesses and governments about the risks they face and how re/insurance can help.

“Communicating the value that re/insurance brings is not something that we do well as an industry,” he says.

“At AXA XL we are in process of finalising a report that we worked on with the Cambridge Centre for Risk Studies around the value that insurance brings when managing post-disaster recovery.”

The report, which is expected to be released in September, shines a light on the importance of resilience in terms of communities recovering after an event.

“Resilience comes in many forms, with insurance being one of those opportunities,” MacFarlane concludes.

“The more we are able to put information in front of governments and regulators, the more re/insurance should be able to help to close the protection gap and reduce the risks communities may face related to the evolving risks associated with a changing climate.” 

Andy MacFarlane is the leader of AXA XL’s public sector partnership working group. He can be contacted at: Andrew.MacFarlane@axaxl.com

Andy McFarlane, AXA XL, Climate change

Bermuda Re