Insurance-linked securities: Recalibrating hurricane risk for a changing climate
A new academic study, co-authored by Benjamin Hohermuth, suggests that rising losses are driven not only by stronger storms but also by changes in hurricane frequency, an often-overlooked factor in catastrophe risk assessment.
Autheurs
The (re)insurance industry faces an increasingly uncomfortable question: what if the catastrophe models used to price risk are calibrated to a climate that has fundamentally changed?
That question sits at the heart of a paper published in the Journal of Catastrophe Risk and Resilience, Recalibrating Risk: A Simplified Model for North Atlantic Hurricanes in a Warming Climate, co-authored by Benjamin Hohermuth, Senior Natural Catastrophe Specialist in Schroders Capital's Insurance-Linked Securities team, alongside researchers from ETH Zurich, MeteoSwiss and Stanford University.
For decades, catastrophe models have largely relied on historical observations to estimate future hurricane losses. While these models remain essential tools for risk management and pricing, they were generally designed around a relatively stable climate baseline.
As global temperatures rise, however, and to paraphrase the standard financial industry disclaimer, historical experience may not be a reliable guide to future risk. This in turn has important implications for how insurers, reinsurers and investors think about hurricane risk.
Why this matters
North Atlantic hurricanes rank among the most economically significant natural catastrophes globally. Losses have increased substantially over recent decades, driven by a combination of growing coastal exposure and changing climatic conditions.
Between 2010 and 2019, tropical cyclones caused over $573 billion in economic losses globally. At the same time, sea surface temperatures in the Atlantic have reached record highs in recent years, fuelling concerns that hurricane activity may be entering a new regime.
The challenge for risk managers is that climate change does not only alter the severity of storms. It can also influence how often storms form, where they travel and how frequently they make landfall. These shifts are difficult to capture using conventional modelling approaches that are calibrated primarily on historical data.
The paper’s authors therefore set out to develop a simplified, but physically grounded, model capable of estimating how hurricane landfall rates may evolve under different levels of global warming.
At the centre of the study is the Schroders Capital in-house ILS risk model. Drawing on both historical hurricane records and climate data, it provides a framework for assessing how hurricane frequency and intensity may evolve as the climate warms.
Rather than replacing existing catastrophe models, it is designed to complement them by applying climate-adjusted hurricane frequencies to standard Year Event Loss Tables (YELTs), a common output of industry tools used to estimate expected catastrophe losses.
By modifying event frequencies to reflect evolving climate conditions, the authors create an updated view of hurricane risk without requiring a complete rebuild of existing catastrophe modelling frameworks.
The hidden role of hurricane frequency
Perhaps the most striking conclusion from the paper is that changes in hurricane frequency may be more important than many market participants currently appreciate.
Much of the climate discussion around tropical cyclones has focused on storm intensity. Scientific consensus increasingly suggests that the strongest storms are likely to become more intense in a warmer world.
Under today's climate conditions, which the authors define as approximately 1.2°C warmer than pre-industrial levels, average annual hurricane losses are estimated to be around 15% higher than under the historical baseline. The increase is particularly pronounced among higher-category storms, with Category 4 and Category 5 landfalls rising by more than 20%.
Under a 2°C warming scenario, the model projects average annual losses that are in excess of 40% higher than the historical baseline, with major hurricane landfalls becoming increasingly common.
Yet the real story may not be storm strength. The research suggests that the frequency of hurricanes plays a larger role in driving losses, with more storms making landfall contributing more to loss growth than increases in intensity alone.
This is particularly relevant for the ILS sector. Storm intensity risk is already widely recognised and often incorporated into modelling assumptions. Risk related to the frequency of storms over certain intensity thresholds may be less visible, but potentially just as, if not more, consequential.
Implications for insurance-linked securities
The findings reinforce a broader trend that investors have increasingly recognised in recent years: climate change is becoming a material factor in catastrophe risk pricing.
Understanding how climate trends translate into losses is becoming increasingly important for investors. If catastrophe models fail to capture shifts in the underlying risk characteristics, pricing and portfolio decisions could be based on an incomplete picture.
The results of the paper portray how the relatively modest shifts in hurricane activity can translate into meaningful changes in expected losses. At the same time, the study highlights the importance of looking beyond headline loss metrics.
The authors find that climate-related increases for more frequent loss events can be adjusted for using resampling approaches, while the impact on rare events is more difficult to capture and requires more detailed models. Schroders Capital continues to address this problem in an ongoing collaboration with ETH Zurich, using state-of-the-art weather prediction models.
This distinction matters because different segments of the insurance value chain are exposed to different parts of the risk spectrum. Primary insurers, reinsurers and capital market investors may therefore experience climate effects in different ways – and it is important to understand the implications along the whole risk transfer chain.
The study also reinforces our view of why an in-house ‘own’ view of risk matters; building on advanced, independent risk models that have been developed over long periods of time, but applying additional criteria and updated modelling assumptions. Recognising that vendor models used by the majority of managers can have inherent limitations, we believe this can enable us to make fundamentally better investment decisions on behalf of our clients.
You can read the full paper on the Journal of Catastrophe Risk and Resilience here.
Further reading:
Subscribe to our Insights
Visit our preference center, where you can choose which Schroders Insights you would like to receive.
Autheurs
Topics