ALEA JACTA NON EST ! OUR RESPONSE TO ECB & EIOPA ON CLIMATE CHANGE & INSURABILITY

SINGULARITY

In 2013, the European Commission published a “green paper” on catastrophe insurance[1], stating about climate change :

“(…) With climate change, insurance will be called upon to cover increasingly frequent and intense events. Changes in climate, demographics and population concentrations, growth in catastrophe-exposed areas and rising wealth and property values are increasing the exposure and vulnerability of economic assets and the severity of losses. In the short term, the effect of climate change on insurance may not be that significant. However, in the longer term, particularly in sectors or areas where insurance has not been customary, climate change could have an impact on the availability and affordability of insurance. Potential losses are highly dependent on changes in exposure and vulnerability. Overall, the probability of most types of extreme weather events is expected to grow significantly. As a result of increasing risks, insurance might become unavailable or unaffordable in certain areas. Unavailable insurance, one of the factors that contributes to vulnerability, may exacerbate the susceptibility of society, leaving governments with potentially large financial exposures. (…)”

We don’t know what the European Commission meant with “short term” and “longer term” ten years ago ? But very probably, short term did not mean 2023. In 2023, stating that?“(…) the effect of climate change on insurance may not be that significant (…)”?would be a clear understatement. In 2023, because of climate change, the world insurance sector is in full swing.

For instance, the G7 Ministers of finance meeting in May 2023 evokes climate change and the widening insurance protection gap[2]?:

“(…) Given increased frequency and severity of natural disasters that are exacerbated by climate change, enhanced coordination by the private and public sectors, especially for vulnerable countries, is critical in promoting disaster risk finance, including insurance, in order to narrow protection gaps. We support ongoing initiatives, such as the joint V20 and G7 initiative of a Global Shield against Climate Risks, regional catastrophe risk pools. We encourage more creditors to offer Climate-Resilient Debt Clauses for loan agreements. We welcome the technical note by the WBG on recent progress and new frontiers of financial resilience against climate shocks and disasters. We also look forward to a report by the International Association of Insurance Supervisors (IAIS), in collaboration with the OECD, on how to strengthen economic and financial resilience against natural disaster risks by the end of 2023. (…)”

In 2001, in its Third Assessment Report, the IPCC[3]?estimated that :

“(…) There is high confidence that climate change and anticipated changes in weather-related events that are perceived to be linked to climate change would increase actuarial uncertainty in risk assessment and thus in the functioning of insurance markets. (…)”

2023 : Here we are ! …

ALEA JACTA NON EST

After our response to International Association of Insurance Supervisors May 2023 consultation (CATASTROPHE OF CATASTROPHES : 2022 REINSURANCE YEAR ZERO Crisis in the climate catastrophe insurance market – May 16 2023), here is our comments to April 2023 EIOPA & ECB Working paper on the insurance protection gap and climate change.

COMMENTS ON?

EIOPA & ECB Discussion Paper – April 2023

“Policy options to reduce the climate insurance protection gap”

“The European Insurance and Occupational Pensions Authority (EIOPA) and the European Central Bank (ECB) have worked together on how to enhance the insurance of European households and companies against climate-related catastrophes. Our joint discussion paper sets out possible actions to increase the uptake and efficiency of catastrophe insurance while?creating incentives to adapt to and reduce climate risks.?

The ECB and EIOPA would welcome comments and feedback on all aspects of the discussion paper by 15 June 2023.?

Introduction[1]

Solicited by European Union in 2017 on Sustainable Finance[2],?our contribution?was then a preview of EIOPA/ECB April 2023 discussion paper :

"(...) A goal of resilience directly involves the P&C insurance industry, through the implementation of territorial solidarity in the face of rising physical risks (floods ; winds etc...) due to climate change.

Europe can be the place for solidarity-based and responsible mutualization in the face of a risk that is likely to grow in the years to come. If the markets can contribute to this mutualization (CAT insurance; reinsurers, etc.), it seems inevitable that questions of insurability will arise with the growing tensions affecting certain regions and countries. See France's policy on Nat Cat.

With a view to creating a "World Insurer" on the model of the World Bank, a European structure could initially play this role of managing risk pooling on an EU scale, bringing together public action and private players, facilitating the transfer of know-how in the field of prevention; supporting cooperation between national meteorological services; promoting the coordinated deployment of assistance intervention resources (assistance providers, often subsidiaries of insurers; NGOs; military forces...).

An initial study should assess the resilience of public and private insurance systems in Europe and other countries and regions (e.g. Florida), and define the most appropriate public policy guidelines for the situations to be anticipated. (...) "[3]

So, in principle, EIOPA/ECB discussion paper initiative (the “EU Fund”) should be supported, that appears to be a follow-up of our 2017 proposal.?

Unfortunately, it might be too late now for cooperation in Europe, as nothing was done during those lost six years :

-???????climate change impacts are more and more tangible now in Europe (Germany and Belgium 2021 ; France 2022 ; Italy and Spain 2023 …etc ) : mutualization of such high risks will be difficult to promote politically.

-???????post-Brexit, and with many inter-states tensions in Europe, solidarity might be less and less present in the European project mindset. The political will might be no longer there.

For instance, in France, a governmental mission was launched in May 2023 on climate risks insurability[4],?“(…) tasked with drawing up an inventory and recommendations on the evolution of the French insurance system in the face of the challenges posed by Climate Disruption. (…)”.

Nowhere in the announcement, there is any mention of Europe.

"L’Europe ne progresse qu’au travers des crises??, Jean Monnet, a founding father of Europe, said in 1962. The 2022 world climate risks reinsurance crisis could have been an opportunity for Europe. A sort of wake up call ? But EIOPA/ECB paper does not acknowledge the depth of the 2022 reinsurance market crisis, depriving themselves of an argument to plead their case.

The EIOPA/ECB paper rightly sees why European countries, at their national level, will get more and more involved :?“(…) A crucial consideration concerning the insurance protection gap is that the public sector is currently in any case the holder of the residual risk, which makes it liable for large climate-related catastrophe losses that are likely to increase in frequency and magnitude. (…)”

Politically, unfortunates citizens stricken by climate catastrophes will hope for, and get help from, their nation state, as “insurer of last resort”. As protector of last resort. Not from Europe.?

As European nation states are “protector of last resort”, and lot of them have been used to rely on ex-post treatment of climate catastrophe in the past, a central scenario is that nothing will change, and EIOPA/ECB attempt will end with few impact.

With escalating and increasingly tangible climate change risks (catastrophic or chronic, like droughts), debates on (un)insurability are set to be lively in many European countries.

2022 : Climate risks reinsurance market failure - YEAR ZERO

EIOPA/ECB Paper describes accurately what is happening today :

“(…) As climate change is expected to increase the frequency and severity of extreme events, insurance coverage will probably continue to become more expensive and/or less available. An increase in insurance should therefore happen in tandem with measures that can help mitigate the underlying risks, especially as some risks might prove to be uninsurable. (…) Additionally, some reinsurers buy reinsurance from other reinsurers (retrocession), which provides further diversification. (…) Increased losses from natural disasters linked to climate change could prompt insurers to limit the coverage they offer or charge unaffordable premiums. (…)”

It is not a hypothetical scenario, as one could think from the EIOPA/ECB Paper syntax (“will probably”) ; the “and/or” is out of place in this “newspeak” sentence, which could be rewritten : “IN 2022, insurance coverage BECAME more expensive AND less available”.

It will have taken a long time for insurers to make the difference between “climate risks”, and “climate change risks”. Climate change risk IS NOT a continuous increase in climate risk, nor incremental.?

It is discontinuous. Mathematically, it seems to be a “catastrophe”.

Regarding our climate, we are getting further and further away from any kind of "equilibrium", a concept so dear to economists.

Insurers were used to the former kind of risk : “climate risks”. They are now flabbergasted by the later : “climate change risks”. For the (re)insurance industry, it is now BAU : business as unusual. For insurance supervisors as well[5].

EIOPA/ECB paper has chosen not to highlight the 2022 reinsurance market crisis.

This might be a political mistake. It could be a missed opportunity.

May 2023 EIOPA/ECB Workshop on “Policy options to reduce the climate insurance protection gap” was interesting, but disappointing on this very issue[6]. To our question about the 2022 reinsurance market failure, the EIOPA representative, the only authorized public institution to be legitimate to give an answer to that question, provided none :

(1)???EIOPA/ECB uses the expression?“market failure”?in their paper :?“(…) The design of private insurance policies can address these market failures (…)”.

With our question during the EIOPA/ECB workshop, we quoted on the chat webinar the comment on escalating climate risks by ESAs in their March 2023 Joint Committee Report on risks[7], which refers to?“the resilience of the insurance industry”?and?“the resinsurance (…) capacity”?:

“(…) Reinsurance capacity continues to be under pressure from increasing losses to properties and businesses due to climate change. The withdrawal of reinsurance in certain lines of business, price increases and higher net retentions for cedents, may lead to a further widening of the insurance protection gap for climate related natural catastrophes. (…) Going forward, to assess the resilience of the insurance industry and society to climate-related events, it will be key to assess the reinsurance natural catastrophe capacity. (…)”

(2)???in the EIOPA/ECB workshop roundtables, there were no representative of European civil society : no NGO representative, nor representative of European national parliaments ; and no members of the European Parliament.??

This could give the impression that industry leaders – and their international associations - spokespersons would be the only stakeholders and legitimate interlocutors from EIOPA/ECB point of view. The question of climate risks insurability is obviously technical, but first and foremost political : the issue of geographic (inter-national) solidarity ; the issue of temporal (inter-generational) solidarity ; the issue of mutualization ; the issue of public/private partnerships …

In a March 2023 conference on reinsurance by US NAIC[8], an expert of the field, speaking in a personal capacity, presented slides highlighting the reinsurance crisis (Burke 2023)?:

“(…)?Historically, major events change the reinsurance market. (…) Reinsurers not meeting investor needs/expectations??; Retrocessional market – aggregate covers largely evaporate ; (…) Investors question if reinsurer modeling and risk assessment is accurate. (…)”

The EIOPA/ECB Paper describes a coming crisis, with difficult times ahead, when in fact that very crisis did happen in 2022 :

“(…) At the same time, as insurance claims increase, premiums are likely to rise and/or coverage fall, thereby widening the protection gap (…) but insurance coverage is expected to decrease or become more expensive as a result of climate change?(…) Some insurers recently announced their plans to cut natural catastrophe coverage, as the incidence of natural catastrophes exceeds what models have been anticipating. (…)”

Examples of such “coverage cut” are multiplying worldwide, as with the announcement in May 2023 of State Farm, leading P&C US insurance groups, with 8,81% of market share, about California and the “challenging reinsurance market”?[9]?:?“(…)?State Farm General Insurance Company?, State Farm’s provider of homeowners insurance in California, will cease accepting new applications including all business and personal lines property and casualty insurance, effective May 27, 2023. This decision does not impact personal auto insurance. State Farm General Insurance Company made this decision due to historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a challenging reinsurance market.?(…)??

As the WSJ reported in June 2023?: “(…) Insurance companies are pulling back on homeowners’ policies in vulnerable areas nationally out of fear of floods, storms and fires made worse by climate change and soaring costs of rebuilding (…)”[10]

A leading US insurance broker, in its June 2023 Report on wildfire risks[11], evokes a “market dislocation”?:?“(…)?The recent market dislocation signals a new focus on managing wildfire risk.?(…) The reinsurance industry has also gone through a dramatic change since 2017. Historic levels of industry loss from wildfires, hurricanes and other natural catastrophes have led to a significant increase in reinsurance rates, higher retentions and contractual tightening over this time span. (…)?The cost and availability of reinsurance as a risk-financing mechanism have come under persistent pressure. (…) Given the current environment of restricted capacity and high prices along with wariness around wildfire exposure from reinsurers (…)”

EIOPA/ECB Paper :?

“(…) However, modelling and insuring losses becomes more challenging, even for reinsurers, in the case of extreme events that are very rare but can cause very substantial economic damage when they occur. At such very high loss layers, the traditional model of reinsurance starts to reach its limits, causing reinsurers to either charge very high premiums or stop underwriting catastrophe risks altogether (“hard market”). This has a knock-on effect on primary insurers and policyholders – they must either pay a very high premium or bear the risk themselves (retention). As such, climate-related risks may not be sufficiently insured by the private sector, and this problem is expected to worsen with global warming. Public sector intervention may then become necessary to supplement the insurance provided by the private sector. (…)”

On can call it a “hard market” instead of a “market failure”. EIOPA/ECB express themselves in the present tense. EIOPA/ECB should just admit there was a catastrophic reinsurance market in 2022[12]?!?

The nature and assessment of climate change macroeconomic risks

EIOPA/ECB Paper :?“(…) Expected annual damages from climate-related catastrophes in the EU and the United Kingdom are estimated to increase from a baseline of 0.17% of GDP to 0.29% in 2050 if global temperatures increase by 2°C on average by 2050 and there are no adaptation or mitigation measures. (…)”

This EIOPA/ECB 2050 forecast might be misleading, and could provide a false sense of relative security to European non-experts readers. EIOPA/ECB analysis is very probably underestimating the impact of perils to come :

1.?????France is studying a +4°C adaptation scenario, which is the translation for France of a +2°C scenario for the planet. One can guess it would be the same for all Europe. As the impact are already tremendous at +2°C for today’s France and Germany etc …, and as the phenomenon are nonlinear, it is difficult not to forecast dramatic impacts with interconnected sub-impacts (“known unknowns”) at +4°C. As EIOPA/ECB Paper rightly states :?“(…) past losses could become unreliable for estimating future losses. (…)”. We would just change the?”could”?in?“will”…

2.?????This kind of na?ve forecast probably rely on exogenous growth assumptions, which are weak hypothesis, to say the least. At last some macroeconomists are starting to grasp the size of the decarbonization challenge for modern economies. Implicitly, for most macroeconomists, GDP is supposed to rise in the coming years : that is an exogeneous hypothesis with weak foundations (IMF 2023 ;??Word Bank 2023)[13]. Economic growth in Europe could be close to zero in this decade. Maybe negative.

3.?????So assets at the numerator level will be more and more impacted (“Expected annual damage”) ; and GDP at the denominator level might be much less that anticipated. But this is not the end of it. The very valuation of assets destroyed or imperiled by a dysregulated climate will be more and more under question. What is the value of a house in a baren desert ? What is the value of a firm which is flooded every couple of years ??

The historical concept of “asset accumulation” in the most exposed geographical zones to climate risks must be reconsidered, as they might be the real “stranded assets” of our times.

With a bit of insight, it is worth reading what William Nordhaus, who was awarded the 2018 “Nobel Prize in Economic sciences” for its academic work on climate change economics, has written about the cost of adaptation to climate change.[14]?It certainly tells a lot about “economic sciences” …

Historical and national background

Unfortunately, EIOPA/ECB Paper provides no historical dimension to its analysis. In 2015, the famous speech by M. Carney on finance and climate change was inspiring. He raised good issues and challenges for the finance industry, and was clear that “nationalization” would be an option[15].

When we first had a look at the link between adaptation to climate change and finance, we were glad to discover that the European Union had been investigating that very subject at the beginning of the 2010s. A few reports were published then[16]. Then all stopped. Our conclusion was that national insurance frameworks in Europe were so wide apart, the insurance systems maturity were so uneven, that nothing could be shared between European countries. Certain insurance industries in western Europe are centuries old. And even within western Europe, past political options regarding catastrophe protection have made shared policy extremely difficult.

The quasi absence of historical benchmark between countries in the EIOPA/ECB Paper is penalizing. We recommend that EIOPA from now on monitor each European insurance national system :

-????????with its recorded insurance and catastrophe history ;

-????????with detailed historical reaction and impacts to most recent events (in Belgium in July 2021 ; in Emilia-Romagna in 2023 …) ;

-????????with political historical debates on insurance systems future (e.g. in Germany Q2 2023 ; in France Q4 2023…)

Such a monitoring would highlight the key issue of systemic risks, and interaction between European countries. Recent droughts in Europe might be a good example.

Europe should capitalize on the diversity of its national insurance markets. Countries will have to try and experiment new models of insurance (long-term insurance policies ; adaptation ; preventive measures etc …). EU should benchmark these very different national systems and experiments, and promote best practices within Europe.

For instance, mandatory insurance is a now understood as a key issue for the mutualization of risks.[17]??EIOPA should benchmark residential housing insurance in France and its history, an insurance which is quasi-mandatory. It should monitor 2023 Germany political debate on the same issue. It should monitor the long history of France agricultural insurance (unsuccessful) reforms, as it is non-mandatory.

Temporal solidarity

The intertemporal solidarity proposed by EIOPA/ECB is politically dangerous.?

The EIOPA/ECB Paper proposes that the insurance “EU Fund” it is calling for (“(…) an EU-wide scheme should cover all relevant types of climate-related hazards facing EU Member States, such as storms, floods and wildfires, but with a clear focus on infrequent large-scale disasters. (…)”), could be financed by fiscal measures.?

This “EU fund” could get its funding, in certain circumstances, from the capital markets :?“(…) In this regard, it would be efficient to provide any EU scheme with a borrowing capacity to raise funds against either its stock of cumulative contributions or Member State guarantees in the event of large pay-outs, especially given uncertainties around the costs of future economic losses from climate-related disasters. (…)”

1.?????The mechanism seems to be -badly- inspired by an annoying historical precedent such as July 2021 catastrophic flood in Belgium. See BNB Annual report for 2021[18]. Wallonia Region took?charge of the part of catastrophe costs that was not taken by insurers (losses from 40% to 100%). This public spending was financed by a 10-years bond emitted by Wallonia Region.

2.?????This mechanism raises the question of transgenerational solidarity. Why should our descendants pay for events caused by us, and our parents ?

Reinventing “long-term”

One of the key challenges for the P&C insurance industry will be to reintroduce long-term relationship with customers, as suggested by EIOPA/ECB Paper[19]. That would allow investments (on both sides) enabling to improve customers resilience.?

Unfortunately, most of today’s insurance policies are one-year contracts. This enables the insurer to reprice quickly when the risks rise dangerously, which is a sound and common practice in the industry. But on the other hand, it prevents long-term investments, as the rewards on these investments would be obtained eventually by another insurer.

EIOPA/ECB Paper, refereeing to these benefits from long-term relationship, states that :?“(…) Unlike traditional non-life insurance, cat bonds are typically structured to provide cover over multiple years, which can help to deliver some of the benefits mentioned above. (…)”.

We would be glad to see EIOPA or peer-reviewed academic studies supporting such a claim.

Market “magic”

EIOPA/ECB Paper states the usefulness[20]?of alternative equity funding of reinsurance through market vehicle, like ILS and CAT bonds :?“(…) Cummins and Trainar (2009) argue that for such risks, issuing equity shares may not be the best way to access the capital markets. This is where alternative risk transfer mechanisms such as insurance-linked securities (ILS) can be useful. (…) They allow catastrophe risk to be transferred to a wider set of investors, thereby diversifying (re)insurers’ sources of capital. (…) “

The view that markets could be THE solution to provide extra capital to the longtime underperforming reinsurance industry (Moodys 2023)[21]?is weakly supported and substantiated in EIOPA/ECB Paper.

At least, EIOPA/ECB Paper is keen to point to ILS/CAT Bonds market weaknesses[22]:?“(…) Certain conditions could trigger a sudden retreat of investors. These include an increase in interest rates, which would diminish search-for-yield behaviour, underestimation of underlying risks by either party or any situation that is not favourable to a “quick-entry, quick-exit” model. (…)”[23]

Moreover, EIOPA/ECB Paper admits that long-term relationships between insurers and reinsurers are an asset.[24]

One of the main market drivers of this alternative ILS/Cat Bond financial market development in the two last decades could have been the US and ECB unconventional monetary policies that brought interest rates to the ZLB, worldwide.?

ECB economists should investigate that argument, and the present situation shortcomings :

-????????the level of low interest rates, and the mainstream idea that it was “low for long” pushed investors toward less liquid assets, but also toward much more risky assets. As well as the shale oil and gas industry, which was new, and where hundreds of billions of dollars were invested with no return from 2010 to 2019, alternative reinsurance market was an attractive market.?

-????????Understanding by most investors of the catastrophe risks was close to naught, and they had no mean to challenge the price proposed by reinsurers which were promoting those bonds to the market. But the storytelling was nice and the social utility of those assets, “public protection”, obvious.

-????????The main way to convince institutional investors was an alignment of interests between the reinsurance company and the investor to which the risk was transfered, as the same risk was partly kept in the balance sheet of the reinsurance emitter. The trust came from that alignment. It was misleading because the reinsurance industry was unable to manage this climate change risks[25].

On a long-term basis, ILS does not seem a good investment strategy for institutional investors. EIOPA/ECB Paper provides no arguments in favor of this thesis. The search for diversification was a key driver in the 2010s. Such as crypto assets and NFTs. That might be over now, when nominal interest rates are once again in positive territory.?

Macroprudential risk and fragmentation

The EIOPA/ECB Paper points to a growing risk :?“(…) a lack of insurance may prevent the qualification of some property as eligible collateral, potentially increasing the exposure of banks to credit risk. (…) A widening insurance protection gap may also pose financial stability risks and reduce credit provision in countries with large banking sector exposures to catastrophe risk events. (…) Finally, in the banking sector, risks associated with a lack of insurance against climate-related disasters may trigger higher capital needs for existing lending and could lower credit supply. Targeted prudential/macroprudential regulations may therefore be needed to enhance the banking sector’s resilience to the implications of a persistent climate insurance protection gap. (…)”

Just behind the issue of residential housing insurability, comes the issue of residential housing financing, and behind it, the whole housing market is at stake.[26]?As the issue of residential (un)insurability will get more and more audience worldwide, the question of covered bonds and securitization of these portfolios of uninsurable mortgages will raise.[27]

Facing this tremendous challenge for national residential housing credit market, how European solidarity will be able to prevent the European insurance market fragmentation ??

For instance, the French residential housing credit market, and its partial coverage of climate risks through the CATNAT framework with the CCR public/private partnership, is close to provide a level?of long-term protection that those of many European countries will be unable to reach.[28]

As the ECB explains in its last its May 2023 FSR[29]?:?“(…) Explicit costs, such as damage to infrastructure and property, and implicit liabilities, such as guarantees for private investments and the financial sector, can become increasingly significant. (…)”

EIOPA/ECB Paper :?“(…) Finally, regarding the banking sector, as discussed in Section 1.2, a lack of insurance may increase risks associated with lending secured by property exposed to climate-related catastrophes or prevent some property qualifying as collateral. This may trigger higher capital needs for existing lending and could lower credit supply. However, physical risk can also be mitigated by improving adaptation of properties. Given these considerations, targeted prudential/macroprudential regulations in the banking sector may be needed to enhance its resilience to the implications of a persistent climate insurance protection gap.(…)”

Once again, the “may be needed” is an understatement.

CONCLUSION

Under pressure, IAIS has launched in March 2023 its review of climate change risks[30].

EIOPA & ECB launched their working paper on insurance gap in April 2023.

France has launched its review of “insurability” in May 2023[31].

In May 2023, a large part of the ECB Financial Stability Review (FSR)[32]?was devoted to physical climate change risks :?“(…) More severe catastrophes in the future could have the potential to affect some countries’ solvency and liquidity abruptly, with possible implications for the accessibility and cost of sovereign financing.?(…) More generally, countries should develop their fiscal frameworks to identify and account for the costs of natural disasters, adaptation and mitigation in order to make informed trade-offs. This requires better information and data and improved governance and management of climate risks. (…)?Contingent liabilities and risk - reduction and adaptation policies?-?Governments can themselves face the risk of having to step in to cover some of the costs of climate risk (…)??

With 6 times “insurance protection gap” ; 13 times “physical risks” ; 12 times “catastrophe” ; 12 times “adaptation”, ECB May 2023 FSR does see climate risk as a potential menace to financial stability.

But there is no feeling of urgency in May 2023 ECB Review, and the reinsurance market failure of end 2022 is ignored. Not even mentioned.

Unfortunately, the (re)insurance crisis is here, and right now.

Michel LEPETIT

THE SHIFT PROJECT

Vice-President

[1]?This response to EIOPA/ECB solicitation is part of our current analysis on this immense and growing issue.

See our May 2023 response to IAIS solicitation :

CATASTROPHE OF CATASTROPHES : 2022 REINSURANCE YEAR ZERO Crisis in the climate catastrophe insurance market – May 16 2023

[2]?Questionnaire by the High Level Expert Group on sustainable finance interim report”

Question N°12 :?“Do you have any comments on the policy recommendations or policy areas mentioned in the Interim Report but not mentioned in this survey?”. In fact, our answer (20/09/2017) to this question had no connection with the HLEG Interim Report policy recommendations …

[3]??Questionnaire by the High Level Expert Group on sustainable finance interim report

Under “Global Warning” –answer to?question N°12?:?

“(…)?Un objectif de résilience implique directement l’industrie de l’assurance IARD par la mise en ?uvre de solidarités territoriales face à la montée des risque physiques (inondations?; vents etc…) due au changement climatique. L’Europe peut être le lieu d’une mutualisation solidaire et responsable face à un risque qui va probablement cro?tre dans les années à venir. Si les marchés peuvent contribuer à cette mutualisation (assurance CAT?; réassureurs …), il semble inévitable que des questions de non assurabilité se poseront avec les tensions croissantes affectant certaines régions, certains pays. Voir la politique publique des CATNAT en France. Dans la perspective de créer un ??Assureur mondial?? sur le modèle de la Banque mondiale, une structure européenne pourrait dans un premier temps jouer ce r?le de gestion de la mutualisation des risques à l’échelle de l’UE, conciliant action publique et acteurs privés, en facilitant par ailleurs les transferts de savoir-faire en matière de prévention?; en soutenant les coopérations entre services météorologiques nationaux?; en favorisant la mise en oeuvre coordonnée de moyens d’interventions d’assistance (assisteurs, souvent filiales d’assureurs?; ONG?; forces militaires …). Une étude initiale devrait évaluer la résilience des systèmes assurantiels publiques et privés en Europe et dans d’autres pays et régions (cf Floride), et définir les orientations de politique publique les plus appropriées aux situations anticipées.?(…)??

[4]?https://presse.economie.gouv.fr/26052023-cp-bruno-le-maire-et-christophe-bechu-lancent-une-mission-sur-lassurabilite-des-risques-climatiques/

[5]?EIOPA/ECB Paper :??“(…) The Solvency II review proposals of the European Commission outline, among other things, measures that contribute to these goals.(37) They would also require EIOPA to review regularly the scope and the calibration of parameters of the standard formula pertaining to natural catastrophe risk. (…)“

This might be far from the mark. We invite EIOPA to prepare a loud “mea culpa”:??Solvency II framework was obviously not based on those kinds of risks that were coming with climate change. EU and EIOPA should announce a revision of this regulation and launch “Solvency III” as a “wartime” regulation of the insurance industry in order to face – or at least try to face- one of the highest challenges of our civilization.

[6]https://www.ecb.europa.eu/pub/conferences/html/20230522_ecb_eiopa_workshop.en.html

[7]?EBA/ESMA/EIOPA Joint Committee Report on risks and vulnerabilities in the EU financial system – March 2023 -– 25/04/2023

[8]?Burke D. - Reinsurance?: back to basics - NAIC CIPR Conference?– 14/03/2023

https://naic.soutronglobal.net/Portal/Public/en-GB/DownloadImageFile.ashx?objectId=10010&ownerType=0&ownerId=26402

Vice President,??State Relations, Reinsurance Association of America?

[9]?State Farm General Insurance Company : California New Business Update – May 26, 2023

[10]?WSJ - Home Insurers Curb New Policies in Risky Areas Nationally - Pullback goes beyond California and Florida as insurers face climate risks and inflation– 8/06/2023

[11]?Gallagher re - 2023 US Wildfire - State of the Market - June 2023

[12]?EIOPA&ECB Paper Chart N°1 only displays the price hike of climate reinsurance in 2022. It omits to display the missing reinsurance capacities that made 2022 a market failure.

[13]?World Bank??(2023)??- Falling Long-Term Growth Prospects – March 2023

IMF (2023) - IMF WEO 2023 – April 11, 2023

[14]?Lepetit M. (2018) - NORDHAUS William (1941-) : L’INVISIBLE MAIN INVISIBLE??- 22 octobre 2018

“(…)

1991- Nordhaus – To slow or not to slow : the economics of the greenhouse effect.- The Economic journal

“(…)??How can nations cope with the threat of greenhouse warming? (…) A first option, taking preventive policies to slow or prevent greenhouse warming, has received the greatest public attention. Most policy discussion has focussed on reducing energy consumption or switching to non-fossil fuels. A second option is to offset the climatic warming through climatic engineering. (…) A final option is to adapt to the warmer climate. This could take place gradually on a decentralized basis through the automatic response of people, institutions, and markets as the climate warms and the oceans rise. If particular areas become unproductive, labour and capital would migrate to more productive regions. (…)”

(…) Our estimate is that approximately 3% of United States national output is produced in highly sensitive sectors, another 10% in moderately sensitive sectors, and about 87% in sectors that are negligibly affected by climate change.

(…) A full assessment of the impact of greenhouse warming must, of course, include regions outside the United States. To date, studies for other countries are fragmentary, and is not possible to make any firm conclusions at this time. A preliminary reading of the evidence is that other advanced industrial countries will experience modest impacts similar to those of the United States. On the other hand, small and poor countries, particularly ones with low population mobility in narrowly restricted climatic zones, may be severely affected. Much more work on the potential impact of climate change on developing countries needs to be done.(…)”

(…) These remarks lead to a surprising conclusion. Climate change is likely to produce a combination of gains and losses with no strong presumption of substantial net economic damages. This is not an argument in favour of climate change or a laissez-faire attitude to the greenhouse effect. Rather, it suggests?that a careful weighing of costs and damages will be necessary if a sensible strategy is to be devised.

(…) Finally, it should be emphasised that this analysis has a number of important oversimplifications. It simplifies enormously many of the intricate economic and climatic complexities by taking a global view of economic activity and a simple dynamic specification of emissions, concentrations, and economic growth. It also bases the economic damage assumptions upon the 1981 sectoral composition of the United States economy and assumes that this composition will hold for the global economy in the mid-21st century.

(…) Notwithstanding these simplifications, the approach laid out here may help clarify the questions and help identify the scientific, economic, and policy issues that must underpin any rational decision. Once the fundamental concepts are clear, it is relatively straightforward to move to a more detailed disaggregated approach so as to fine tune the calculations. But whether we use simple approaches like the present one or more elaborate models, we must balance costs and damages if we are to preserve our precious time and resources for the most important threats to our health and happiness.?(…)”

[15]?Carney M. –Breaking the Tragedy of the Horizon – climate change and financial stability - September 29th, 2015

[16]?European Commission - GREEN PAPER on the insurance of natural and man-made disasters – April 2013

[17]?EIOPA/ECB Paper on French insurance framework :?“(…) Thus the scheme relies on the insurance industry network to ensure widespread coverage. (…)”

[18]?BNB Annual Report 2021?(page 258)??

? (…) 2.2 Inondations de juillet 2021

Les inondations survenues du 14 au 16 juillet 2021 ont causé d’énormes dégats, notamment aux batiments et aux entreprises, et ont eu de lourdes conséquences sur la vie de nombreuses personnes. Même si tous les dommages n’étaient pas assurés, les sinistres assurés ont en grande partie été indemnisés par le secteur de l’assurance et de la réassurance, principalement par le biais de la couverture intégrée à l’assurance incendie pour les ? risques simples ?.Ceux-ci incluent entre autres les logements familiaux, les batiments agricoles, etc., tels que décrits dans la législation (1). Pour ces risques, l’assurance incendie doit obligatoirement comporter une couverture contre l’inondation. Le législateur a imposé cette obligation pour protéger l’assuré contre les catastrophes naturelles. En outre, afin de préserver également la stabilité financière du secteur de l’assurance, par exemple en cas de catastrophes naturelles exceptionnelles, le législateur a instauré par le passé des mécanismes spécifiques, comme une limitation des sinistres à un plafond d’intervention par assureur et par catastrophe, au-delà duquel les fonds régionaux des calamités sont mobilisés. Aucune couverture obligatoire contre les catastrophes naturelles n’est prévue pour les autres risques assurés dans le cadre de l’assurance incendie ou d’autres assurances, telles que l’assurance automobile, mais une négociation au cas par cas peut avoir lieu avec chaque preneur d’assurance.??Compte tenu de l’incidence considérable des inondations de juillet 2021, des protocoles spécifiques ont été élaborés entre les Régions et le secteur de l’assurance, afin d’indemniser aussi vite que possible les assurés et de trouver un équilibre adéquat entre le co?t de financement pour les premières et la stabilité financière du second. Y est prévu d’une part, que les plafonds d’intervention légaux des assureurs seraient doublés à titre exceptionnel et, d’autre part, que ces derniers préfinanceraient au moyen d’un prêt les sommes dépassant cette limite d’intervention majorée. La Région wallonne devrait rembourser ces montants au secteur de l’assurance à partir de 2024. Le total des dégats causés par les inondations est actuellement estimé à 2,1 milliards d’euros. Ces estimations sont toutefois susceptibles d’être ajustées en fonction de l’évolution des dossiers d’indemnisation. (…)??

[Note 1] Article 5 de l’arrêté royal du 24 décembre 1992 portant exécution de la loi sur le contrat d’assurance terrestre. (…) ???

[19]?“(…) One criticism of the non-life insurance and reinsurance industry is that the contracts for risks such as catastrophe risk (and other non-life risks in general) are structured and priced annually. While this feature shields (re)insurers from the effects of material mispricing of risk, it also does little to encourage the incorporation of climate change considerations into the design and pricing of reinsurance because there is always the “short cut” of adjusting the premium after one year. Long-term insurance contracts, which provide a guaranteed price (or guaranteed ceiling and floor price) over a term from 3 to as much as 25 years, could significantly foster adaptation by providing greater incentives for the insured to invest in cost-effective property-level resistance and resilience measures (Maynard and Ranger, 2012). (…)”

[20]?EIOPA/ECB Paper : “(…)?To put the market size in perspective, cat bonds had USD 35.5 billion in capital outstanding at the end of 2022, compared to USD 467 billion in traditional reinsurance capital at the end of August 2022.(…)”

[21]?Moodys - Reinsurers defend against rising tide of natural catastrophe losses, for now - Jan. 10, 2023

[22]?EIOPA/ECB Paper : “(…)?Despite the potential benefits for both (re)insurers and investors, cat bonds are not an easy substitute for traditional reinsurance, especially in Europe. (…)”

[23]?EIOPA/ECB Paper misleadingly comments that?“(…) Investors in cat bonds benefit from low correlation with equity and credit markets. (…)”. The real question is correlation with interest rates …

[24]?EIOPA/ECB Paper : “(…)??By contrast, traditional reinsurers, who typically place more emphasis on relationships with their counterparties, are more likely to keep providing reinsurance capacity across market cycles. (…)”

[25]?EIOPA/ECB Paper :?“(…) In a cat bond transaction, capital market investors face greater moral hazard risk from the party that cedes the risk. This is mitigated by obtaining an independent assessment of the risks being covered by the bond. (…)”

It looks like a na?ve view of climate risk management.

[26]?See for instance NAHB (National Home Builders Association response) response to US FHFA call for comment??(FHFA - CLIMATE AND NATURAL DISASTER RISK MANAGEMENT AT THE REGULATED ENTITIES REQUEST FOR INPUT - January 2021) :

“(…) We are helping to develop cost-effective, market-driven solutions that maintain housing affordability while balancing the needs of growing communities with the need for reasonable protection of life and property. (…)

To this end, we caution FHFA to consider that any changes to risk-management policies for its regulated entities – even if well-intended – could have consequences that impact the housing market and ripple through the entire economy. For this reason, housing affordability and ensuring broad access to credit must be central to the Agency’s deliberations. (…) For example, the Enterprises already require risk mitigation on purchased loans such as flood insurance, homeowner’s insurance, liability insurance and mortgage insurance. (…)?NAHB applauds the FHFA’s efforts to be a world class regulator and consider the increasing threat that climate and natural disaster risk poses to the Enterprises and the FHL Banks. Efforts to address these risks are happening throughout the country at all levels of government and in all industries. NAHB cautions that the nation’s housing finance system is not the appropriate forum to drive these initiatives. FHFA must consider the cumulative impact that regulations to address climate and natural disaster risk will have on the individual homeowner and home buyer, multifamily properties and the mortgage and financial markets. FHFA should keep an utmost focus on ensuring access to credit, particularly for low-to moderate-income home buyers and renters. ?

[27]?US FHFA (Federal Housing Financing Agency) – Federal Home Loan Bank Stress tests for Market and Credit Risk

US FHFA - Credit risk macroeconomic scenarios for stress-testing mortgage Related Assets

[28]?EIOPA/ECB Paper Table N° 1 would be worth much more explanation.

[29]?ECB - Climate change and sovereign risk - Financial Stability Review- May 2023

[30]?Just a few weeks after publishing its consultation on climate risk supervision in March??2023 (IAIS – Public Consultation on Climate Risks Supervisory Guidance (part one) – March 2023), the 2022 (re)insurance market crisis forced IAIS to urgently publish a short position paper on the same subject : (IAIS -?The role of insurance supervisors in addressing natural catastrophe protection gaps?– April 28 2023).

[31]?https://presse.economie.gouv.fr/26052023-cp-bruno-le-maire-et-christophe-bechu-lancent-une-mission-sur-lassurabilite-des-risques-climatiques/

[32]?ECB - Climate change and sovereign risk - Financial Stability Review- May 2023

Footnotes to the introductory post :

[1]?European Commission – Green Paper on the insurance of natural and man-made disasters – 16/04/2013

[2]?G7 Finance Ministers and Central Bank Governors Meeting Communiqué - Niigata, Japan - 13 May 2023

[3]?IPCC – Impacts, Adaptation, and Vulnerability – Contribution of Working Group II to the Third Assessment Report of the Intergovernmental Panel on Climate Change - 2001