As a cub insurance reporter 20-odd years ago I remember being shocked by the brutal economic theory of one old underwriting hand. Amid a cyclical trough in reinsurance pricing, after premiums had been driven down to unsustainable levels by cut-throat competition, he quipped that what the market really needed was a big catastrophe to trigger price rises. Ideally something like a passenger jet flying into a New York skyscraper.
The freakish terrorist attack of September 11 2001, when two aircraft were hijacked and flown into the Twin Towers of the World Trade Center, came only a few years later. And in one perverted way it did the trick. Competition dwindled. The cost of reinsurance — the insurance cover bought by insurance companies — spiked.
According to Willis Towers Watson, the broker, the premiums demanded for US property catastrophe cover jumped 66 per cent between 2000 and 2002.
But that supposed benefit was wiped out by one of the most expensive one-time losses of all time. Claims from 9/11 on policies spanning property, aviation, liability, life assurance, business interruption and many more lines of cover totalled $40bn, according to leading reinsurance group Munich Re. Nearly 3,000 people were killed and a chain of global warmongering was triggered.
Today, as another deadly tropical storm skirts the US east coast, a similar mentality seems still to prevail.
As this article was published, Hurricane Dorian had killed more than 40 people in the Bahamas and destroyed hospitals, airports, harbours, offices, shops and homes.
According to Munich Re, 2017 and 2018 were the worst two-year period for natural catastrophes on record, with insured losses of $225bn.
Climate change seems to be making hurricanes more severe and sparking more wildfires.
The insurance industry looks like it has ample capacity to cope. Over the past 10 years, insurance and reinsurance companies have been joined by new forms of capital, as pension funds and other investors have sought out sources of higher returns than are available in traditional bond markets in the ongoing environment of ultra-low interest rates. Many funds now have a 3 per cent asset allocation to the sector.
But there are signs that worsening climate change risks may be scaring off the new money.
There is a logistical hurdle: when a catastrophe bond experiences a so-called loss event, the capital in the investment is suspended until the full cost of a disaster is pinned down. The phenomenon of “loss creep”, where initial estimates of a loss balloon months or even years after the event, has also spooked some investors. The cost of Typhoon Jebi in Japan last year rose from initial expectations of $6bn to $15bn.
Harking back to the pre-9/11 underwriters’ mentality, the combination of bigger catastrophes and a supply of underwriting capital that might not keep pace with the mounting risks is prompting some analysts to prophesy a boom in pricing and profits.
RBC forecasts: “We believe climate change presents a number of opportunities for reinsurers. We expect that insurance penetration of catastrophe losses will increase as the protection gap [of uninsured losses] narrows.”
Jefferies elaborates: “We expect that this will result in higher prices and demand, prompting industry-wide growth. [We] expect higher growth and margins.”
Up to a point they are probably right.
But a lot depends on the severity of the climate crisis. Regulators are starting to worry about this. The Bank of England’s Prudential Regulation Authority is leading the way on stress-testing insurers against the risk that the world misses its carbon reduction targets.
In such a scenario, insurers, especially in the US where price increases are restricted by regulators, may find it increasingly unattractive to offer coverage. Greater lay-off of risk to reinsurers is one option. But more restrictive policies or wholesale withdrawal of cover are also possible.
At some juncture underwriters will need to remove their blinkers and acknowledge that a world awash with worsening climate change risks is not necessarily just bad for the planet. It could be bad for the insurance industry too. A bit like 9/11.