Less than 50% of insurers consider climate-change material

Written by Mark Thomas

17 January, 2020

Australia is currently experiencing one of the most devastating waves of bushfire activity on record. With approximately 200 fires currently burning, some 5 million hectares destroyed, and 20 lives lost to date. According to information from the Insurance Council of Australia (ICA), 8,985 bushfire-related claims have been lodged as of January 7 across NSW, Queensland, South Australia and Victoria. In its latest figures insurance claims had reached AU$700 million.

According to IAG’s website “IAG has received more than 5,000 bushfire-related claims since the beginning of September and has finalised over 20% of these claims to date.”

 

The challenge of climate change – insurance and investing

Insurance

Climate change poses a significant challenge for insurance companies. It will require new underwriting skills as customers seek to reduce the risk of losses due to climate-related weather events. Climate change also affects how frequently claims are filed and the patterns of claims. Because insurers underwrite carbon-intensive industries and carbon-emitting homes, autos and airplanes, all widely perceived as factors causing climate change, it also carries liability risk. This could pose a significant reputation risk for those insurers that fail to address these issues as part of their underwriting activities.

 Interestingly, in an APRA survey of in March 2019 only one third of regulated entities viewed climate risks as material. However, a wide range of strategic opportunities have been identified to integrate climate risks into risk management frameworks, with more sophisticated financial analysis of various scenarios – good or bad.

 

Organisations considering climate-related financial risk to be material

 

The recently released Moodys’ report  Bushfire insurance losses will mount but remain manageable for Australian P&C insurers states:

  • Fire-related claims will dent profits, but industry’s strong fundamentals will mitigate impact
  • Nonetheless, the catastrophic events highlight insurers’ growing environmental risk

“Although we expect claims to continue to rise, dampening the sector’s profits, they are likely to be manageable as the industry has a long history of strong underwriting discipline” says Frank Mirenzi, a Moody’s Vice President and Senior Credit Officer.

Moody’s expects Suncorp Group, through its subsidiary AAI Limited and Insurance Australia Group Limited to receive the largest sum of gross claims, because of their significant market share in home and motor insurance.

The following chart looks at the share market performance of these two companies over a twenty-year period.  During this period there were many environmental crisis moments. Clearly IAG has performed better than Suncorp (three times their growth).  But most importantly both of these companies recovered from various setbacks and provided solid returns for investors who looked through the crises. Both these companies pay dividends of more than 4 percent per annum and offer high levels of franking credits suggesting a modified gross dividend of closer to 6 percent. Add this to historic share price growth and you get a return range of 8 percent per annum to 10.5 percent per annum over 20 years. There are a few bumps along the way with falls in the share price of 30 percent not uncommon, and greater falls possible, but only seemingly short term. Trading this share price volatility successfully could offer investors much higher growth for example there were four moments in the period where the Suncorp share price rose 50 percent plus post a significant share price fall. Currently share prices are down 10 percent.

Typically, insurance companies will raise the cost of their premiums post crisis contributing to growth in revenues and profits thereafter. Premiums rarely go down.

Losses in the short term are also mitigated by a risk management practice called reinsurance. Reinsurance is insurance that an insurance company purchases from another insurance company to lay off their risk and costs.

Moody’s states “However, QBE Insurance Group Limited and international insurers with large Australian operations such as Allianz SE and Zurich Insurance Company Limited will also be adversely impacted through higher natural peril costs as a result of the bushfires.

According to the insurance industry regulator APRA “gross claims on the industry from the events of 2011/12 have been estimated at $1.0 billion, which was low in contrast to the claims from natural catastrophe events in the previous year (2010/11); the gross claims from the Australian flooding, storm and cyclone events in that year have been estimated at $4.4 billion. while the Christchurch earthquakes resulted in gross claims estimated at US$14.2 billion.”

APRA also states that “A large portion of the industry’s gross property claims arising from the previous year’s natural catastrophe events were recovered from reinsurers.”

Investing

Interestingly this week the worlds largest fund manager BlackRock (BLK.N) who manages $US7 trillion announced a significant shift towards sustainable investing. Chief Executive Larry Fink warned company boards to step up efforts to tackle climate change. This is a significant shift as BlackRock faces mounting concerns about climate change.

In its actively-managed portfolios, it will sell companies that receive a quarter or more of their revenues from thermal coal. BlackRock will also push companies to disclose their climate risks according to widely accepted standards. It now believes sustainable investing is “the strongest foundation for client portfolios going forward,”

Then we have Warren Buffet’s Berkshire Hathaway, the world’s largest general insurer by revenue, who is building the largest solar power station in the world.  They recently announced their plans to build a 690 megawatt solar plant in Nevada. That project and two others will create 1.19 gigawatts of new power, enough to provide electricity to 230,000 homes. The projects also come with 590 megawatts of battery-storage capacity, meaning the power generated by solar panels can be stored for times when the sun isn’t shining.

Buffett said in a 2016 investor letter that he was convinced renewable sources would grow in importance, which is why the company’s Berkshire Hathaway Energy subsidiary was investing in them. “Last year, BHE made major commitments to the future development of renewables in support of the Paris Climate Change Conference,” he wrote. “Our fulfilling those promises will make great sense, both for the environment and for Berkshire’s economics.”

What now?

So, it appears that a strong groundswell is developing in relation to climate change, its consequences, the material costs on society resulting, and the required actions.  Well wouldn’t that be lovely if it were true.  Let’s just say that a lot of discussion is in play, even a mooted Royal Commission into the Australian bushfires. As for the big end of town, some seem to be shifting with the times. For those interested in trading insurance companies it appears that a selective buy on dip would make sense at some point if you dare at this stage of the bushfire season.  Their business model almost needs a crisis to increase its prices and margins.

 

Please consult your advisor for specific recommendations.  This general advice does not take into account the client’s objectives, financial situation or needs as we do not and cannot provide personal advice.  Any views written about in this article are the views of the author who has no holdings in those companies or investments mentioned in this article.

Disaster Relief for Bush Fire Crisis

There are various ways you can help out during this bush fire crisis. Below are links to the Australian Red Cross and also each state’s individual fire services:

Australian Red Cross

NSW Rural Fire Service

QLD Rural Fire Service

VIC Country Fire Authority

SA Bushfire Appeal