Saturday, September 6, 2014

Monetary Policy and Climate Change are Interconnected




Insurance blog Artemis has a great post from a few days ago titled Reinsurers (and ILS) may underestimate climate change exposure: S&P.

The first paragraph says it all (emphasis mine):

“Ratings agency Standard & Poor’s performed some analysis on the global reinsurance sectors exposure to climate change and found that, under a scenario it tested for, reinsurers may be underestimating their exposure to catastrophe losses by around 50%.”

This article confirms what I have long suspected. Reinsurers are more exposed to climate change than their rates would reflect. Living in a ZIRP environment is causing investors to chase yields into instruments like Insurance Linked Securities (ILS) with no clue as to the type of risk they are taking. I think the idea of alternative risk transfer has merit and that it is a great financial tool, however, I bet very few investors understand what they are buying and I question the incentive structure of reinsurers.

What's the difference between packaging subprime mortgages and packaging the equivalent of "subprime" insurance risk? If a reinsuer can simply collect a spread but pass off all or the majority of their risk then their underwriting standards can (and will) quickly become compromised. Caveat emptor.

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