The number of weather-related natural catastrophes is on the increase in Europe. There is growing evidence that this trend is already due in part to climate change. The latest IPCC report confirms that the climate is changing.
The mean global temperature is constantly rising. It has increased by 0.74°C in the last 100 years and by no less than 0.13°C per decade in the last 50 years – double the rate for the 100-year period as a whole. The rate of increase has been even more pronounced in Europe, with a rise of 0.95°C in the last 100 years, and as much as 1.0°C in Germany, 1.1°C in Austria and 1.4°C in Switzerland. The rise in temperature has been even more pronounced in the last few decades.
Munich Re was one of the first companies in the finance sector to draw attention to the problem, pointing out in a 1973 publication on flooding that the growing losses might be due to human-induced climate change. The 2007 IPCC (Intergovernmental Panel on Climate Change) report confirms the statements and warnings we have issued over the last three decades: it is more than 90% probable that climate-changing trace gases released into the atmosphere by human activity are the primary cause of the global increase in temperature. The IPCC also confirms our analyses indicating that climate change is already causing a greater number and higher intensity of weather extremes.
Climate change curbs economic growth
Sir Nicholas Stern’s report on the “Economics of Climate Change”, published in October 2006, addressed the financial impact of climate change. It predicted a reduction in annual global growth of at least 5%, or US$ 2,200bn, by the middle of this century. The Stern Review forecasts that the costs will be limited to 1% of annual global gross domestic product (US$ 445bn) provided we take corresponding action. Such action would enable us to remain below the critical dividing line of a 2°C increase in global average temperatures compared with pre-industrial levels. This objective will only be achieved if CO2 eq concentrations can be stabilised at 445–535 ppm by 2050. Some increase is inevitable due to growing emissions from emerging countries such as China and India.
It is also crucial that we finance steps to adapt to climate change impacts that can no longer be prevented. The insurance industry has a key role to play in this by providing solutions to deal with the financial losses.
Catastrophe losses have vastly increased for insurers in recent decades, five out of six natural catastrophes being triggered by weather extremes. These developments have prompted the need for a re-analysis of the risks posed by weather-related hazards in Europe.
Increasing loss potential
A winter storm can produce insured losses of over ?50bn in central Europe. However, events on a local scale should not be underestimated either. Hailstorm scenarios can cause billions of insured losses in major cities. At the same time, the vulnerability of insured property is increasing due to structural changes, the use of new materials, and the extension of cover.
As a result of selective underwriting, insured losses from floods remain low in central Europe, but the loss potential is growing because of the higher incidence of heavy precipitation, the development of exposed areas, and increasing concentrations of values in the areas at risk. Scenarios involving more than one country are likely to produce losses of several billion euros.
Despite global warming, extreme winters like that of 2005/2006 remain a possibility. Heavy snowfall and prolonged cold spells during which the snow accumulates could cause major losses – as in Austria in 2006, when the insured market loss came to a substantial 300m.
Munich Re considers deductibles an effective means by which insurers can manage the risks, since the burden is more widely shared. Sublimits of up to 50% of the sum insured, on the other hand, are less efficient because, across the portfolio as a whole, they are much higher than the probable maximum loss Munich Re expects for natural hazards. However, sublimits can be useful when applied to individual risks.
Hail and windstorm insurance penetration high
Munich Re has examined various aspects of insurance in Germany, Italy, Austria, Switzerland, the Czech Republic, the Slovak Republic and Slovenia. Hail and storm insurance penetration in the central European countries reviewed is 80–100%, but the figure is generally much lower for flood risks. This is due to the fact that the storm and hail perils are often covered under the fire policy. Market penetration in Switzerland, where the insurance of natural hazard risks (except earthquake) is normally obligatory, is virtually 100%. In Austria, unlike the other countries analysed, the state has set up an emergency fund for exceptional natural hazard events, funded out of tax revenues. However, there is no legal entitlement to compensation.
State help is primarily used to deal with flood risks and reduced agricultural yields. Reduced yields have increased insurers’ loss ratios considerably in some years, resulting in higher premiums for farmers. In central Europe, cover in Austria is among the most comprehensive. In addition to hail, policies also cover frost, windstorm, flood, drought, and prolonged rainfall at harvest time, premiums being subsidised by the state to the tune of 50%. The provision of blanket, state-subsidised multi-peril crop insurance necessitates a risk partnership between the agricultural sector, the insurance industry and the state.
Transferring risk to the capital markets
Alternative risk transfer methods are assuming greater importance, given the growing loss potential. The securitisation of catastrophe risks by the issue of catastrophe bonds on the capital markets has soared since Hurricane Katrina. In 2006, around US$ 5bn worth of catastrophe risk bonds were issued, twice as much as in 2005. In all, catastrophe bonds currently amount to around US$ 15bn. Experts believe that, in the medium term, 20% of catastrophe risk capacity will be placed on the capital markets. In addition, catastrophe risks are traded using insurance derivatives. Thus, companies can protect themselves in the short term against the financial consequences of exceptional weather factors. It is now also possible to place risks with lower return periods (25–30 years), following an initial phase in which mainly top-layer risks were securitised.
Munich Re uses catastrophe bonds to cover weather-related natural catastrophes (windstorm Europe, hurricane USA) and offers both insurance and derivative solutions tailored to the situation of the individual company. Munich Re’s Risk Trading Unit provides support and advice for clients on the transfer of risks to the capital markets.
Effects during the summer half-year
In the course of the 21st century, temperatures will continue to increase during the summer half-year: by 2.5–3.5°C in northern Germany, compared with the 1961–1990 average, and more than 3.5°C in southern Germany, the south-west Czech Republic, Austria, Switzerland, northern Italy and Slovenia. Many places will experience more heatwaves.
Scenarios for Upper Austria indicate heat periods (temperatures remain at or above approximately 30°C for a minimum of 20 days) every two years on average, compared with every 20 at present. There will also be significantly more dry periods – like heat periods, often associated with high-pressure conditions – in Upper Austria, Burgenland and Styria.
According to the results of climate research, Switzerland, the Czech Republic, the Slovak Republic, Hungary, northern Italy and Slovenia can also expect more periods of heat and drought.
Total precipitation in the summer half-year will decrease, but some events could be more intense, so that rainfall will be distributed over a smaller number of occurrences.
One climate model shows that average July–September precipitation will be significantly less than in the period 1961–1990, the reduction being as much as 20–30% in parts of Austria, northern Italy, the Czech Republic, Switzerland and the Slovak Republic.
Conversely, 1% heaviest five-day summer precipitation will increase in parts of northern Italy and northern Switzerland and along a band comprising northern Austria and many parts of the Czech Republic, Poland and eastern Germany.
Models indicate that a warmer climate could mean fewer low-pressure rain systems forming in the northern Mediterranean basin due to central European trough conditions. However, those precipitation events could become more intense.
The tendency towards thunderstorm formation, with the risk of hail, strong gusts, tornadoes, flash floods and lightening, will increase to a varying extent, depending on the region. This trend has been confirmed by observations in the Swiss plateau region and in southwest Germany, where it has been directly measured during the past 30 years.
The Swiss observations show that European weather conditions conducive to thunderstorms also became more frequent in the course of the 20th century. Consequently, local increases of this sort are also probable for other regions of central Europe, although difficult to substantiate at the present time. Climate models are still too approximate to indicate such effects in the projections. In the areas of northern Italy, Slovenia and southern Austria affected by moist air masses from the Adriatic, people will have to be prepared to deal with more severe thunderstorms bringing hail, heavy precipitation and strong gusts.
West European trough conditions
Repeated bouts of extremely severe precipitation along the Mediterranean coast from southeast Spain to Italy and Slovenia cause floods between September and November. Torrential rain events in late summer and autumn are expected to become more frequent and intense in the Mediterranean countries.