Should secondary perils become a primary concern for (re)insurers?
Secondary perils are not new to the (re)insurance industry. The risks presented by wildfires, hail and wind have long been modelled, assessed and underwritten by insurers and reinsurers alike.
What is new, however, is the scale and frequency of risk being presented by these secondary perils.
Figures from Swiss Re’s Sigma Report found that 2021 was the fourth costliest year on record for natural catastrophes, with insured losses of $111bn. More than 70% of these losses were a result of secondary perils – up from 50% of insured losses in 1970 and well above the long-term average.
2021 was also the first time that the world had experienced two $10bn+ secondary peril events in the same year.
“While we do not see a new norm of higher loss growth rates, regular occurrence of multi-billion insured loss outcomes from secondary peril events is new,” says Swiss Re, writing in its latest Sigma Report. “In 2021, two separate secondary perils events – winter storm Uri in the US and devastating floods in central-western Europe in July – each caused losses in excess of $10bn.
“Traditionally secondary perils have been less well monitored than primary. Recent efforts to change this should be further progressed.”
A Changing Risk Landscape
According to Ed Broking’s head of property, James Venton, there are a number of factors driving the increased threat from these secondary perils, “including climate change, population pressures leading to urban development in more hostile environments, and more recently the risk of recession driving cutbacks in infrastructure investment, such as flash flood mitigation and measures to control brush in wildfire-exposed areas,” he explains.
Venton adds that the (re)insurance industry was beginning to wake up to the issue, but that historically it had been an area of the risk landscape that was overlooked by many in the market.
“There is a fundamental view amongst (re)insurance carriers that they have not been historically equipped to model the full gamut of these perils and they continue to be surprised by their locale and severity,” he explains. “Effectively that means they haven’t been sufficiently pricing for them, and with an eye on future risk trends, that is now being addressed.”
Venton cites the example of the derecho events experienced in the US – widespread, long-lived wind storms that are normally associated with a band of showers or thunderstorms – as one example of a change in traditional weather patterns that has hit the industry hard.
“These powerful, sustained straight line winds are not a new phenomenon, but whether due to climate change, the intensification of agriculture or changes in development patterns, they are making headlines in the insurance press for the wrong reasons,” he says.
These headlines include the disproportionate way in which these storms affect certain types of operations – rural grain silos are an area cited by Venton – and this changing risk landscape may already be having knock-on effects to the way (re)insurers manage the risks they are facing.
“There is evidence that certain carriers are reducing capacity and/or charging additional rate for insured’s potentially exposed to the peril,” Venton adds.
This reduction in capacity should be of concern for the (re)insurance industry. Especially with Swiss Re’s figures revealing that the $111bn of insured losses from natural catastrophes in 2021 only accounted for around 40% of the overall economic losses resulting from these events, resulting in a serious insurance gap across the globe.
A Tech Revolution
Luckily, Venton says that technology is now beginning to emerge to address this problem.
“Technology is revolutionizing the understanding that carriers can develop around secondary peril exposures,” he says. “It provides more confidence and underpins the business plans of the many specialist startups looking to step into the space left behind as traditional carriers seek to limit coverage or exclude them entirely.”
One of the areas Venton highlights as a particular bright spot on the horizon is parametric insurance, citing wildfire and flood as key areas of application for this fast-growing area of insurance.
“Pixelated satellite imagery of historical burnt areas for wildfires woven into algorithms are enabling parametric carriers to provide alternative offerings to the blunt pricing models of traditional markets still prepared to roll the dice,” he says.
“Along similar lines, flood modelers are harnessing rapidly improving intelligence to overhaul the FEMA classifications allowing for a much more accurate understanding of these exposures, which should over time enable a more bespoke approach to coverage.”
And Yordanka Velichkova, Catastrophe Perils Portfolio Lead at Swiss Re, says (re)insurers are also waking up to the increased risks presented by secondary perils, but say that these risks also need to be considered as part of the overall picture presented by natural catastrophe risks.
“We heavily invest into proprietary research and modelling of natural catastrophes to allow highly bespoke underwriting and risk-taking and remain a reliable source for (re)insurance protection for our clients,” she says. “Our proprietary models consider the effects of all relevant factors driving insured losses such as climate change, and accumulation of wealth in exposed areas.
“All natural catastrophe perils deserve explicit attention for pricing and risk transfer, as macro risk drivers are relevant for all, irrespective of tail or frequency. But the steady increase in insured losses requires the industry to adjust their understanding of the risks and related insurance.”
And with Swiss Re warning that there is “no reason not to expect repeat occurrences” of the large secondary losses caused by the likes of winter storm Uri and the European flood events, the (re)insurance industry and its insurtech partners need make this adjustment quickly if they are to get to grips with secondary perils before it is too late.