This article can be viewed online at: https://www.mynewmarkets.com/articles/183982/a-paradigm-shift-from-buying-insurance-to-selling-risk
A Paradigm Shift, from ‘Buying Insurance’ to ‘Selling Risk’
Rising commercial property insurance costs have gotten the attention of executives across a broad cross-section of corporate America. Aon, a leading broker of commercial insurance, reports that commercial property insurance premiums have experienced, on average, double-digit increases for five years in a row.
One driver of these increases has been an ongoing spate of catastrophic weather events. For example, Munich Re reported that in 2021 the global insurance industry paid $120 billion in catastrophe claims, the second-largest annual loss ever recorded. Of that loss, $85 billion was in the U.S. alone, driven by the Texas freeze, Hurricane Ida, and the December tornado outbreak across the central and southern U.S.
While it’s difficult to attribute any specific event, or any year’s activity, to climate change, experience, data and science tell us that volatility is increasing and that the frequency of severe weather events is almost certainly going to increase further in the coming decades. For example, NOAA’s recently published 2022 Sea Level Rise Technical Report projects about a foot of average sea-level rise along the U.S. coastline by 2030. By 2050, the frequency of major coastal flooding events will increase by a factor of 5X from current rates. The consequences of our changing climate will not be limited to coastal flooding; warmer waters will spawn more severe hurricanes, and shifting weather patterns will likely lead to more extreme tornado and hail outbreaks, severe convective storms, polar vortex disruptions, and inland flooding.
While insurance premiums can fluctuate due to the vagaries of market pricing cycles, the fundamentals are becoming clear: the costs of property risk will trend higher, forcing insurance buyers into a Hobbesian choice of higher costs or less coverage. As many insurers price with a view to their entire portfolios, the impact will be felt broadly across the country and not just in catastrophe exposed regions.
On the front lines of these impacts are the owners of, and institutional investors in, commercial property. With trillions of dollars in property assets under management, most owners in the commercial real estate business have already experienced significant increases in their costs to insure the replacement costs of their buildings. Yet this goes beyond real estate companies: every major business leases property, and rising insurance costs are often allocated to the tenants via their leases.
Businesses of all stripes own, and insure, their own buildings; and in any case also purchase property insurance to cover the contents, equipment, and inventories inside of all the locations they operate from, not to mention insuring the business interruption losses linked to the disruption of the business due to physical damage to the structure where business is conducted.
Traditionally, corporations buy property insurance on an annual basis and often do so with policies that cover the entirety of the properties in the company’s portfolio. Underlying a company’s insurance program is a schedule that for the larger buyers can involve hundreds or even thousands of insured locations.
Each year, their risk management teams work closely with their insurance brokers to update their exposures and loss histories, assess their needs, and then syndicate their ‘placements’ across a wide range of insurance companies. These insurers, in turn, underwrite and price the coverage based upon their analysis of the risks to the buildings, including from catastrophe and weather-related events. Ultimately, the policies are priced by the insurance markets using a mix of technical methods, underwriters’ experiences and judgment mixed with a shot of market ‘sentiment.’
Implied in this process is that the insurance markets understand how to price their customers’ risk better than their customers do. Buyers then react to this pricing and tune their buying decisions accordingly, yet often having to accept the prices offered to secure adequate coverage. Not surprisingly, a 2021 survey by Advisen reports that only 29% of property insurance buyers for large companies are “satisfied with their understanding of how their insurers price their risk”, and 79% report they are “likely to retain more risk” in the future than they do today.
Given recent trends, there is now a paradigm shift underway in how large companies manage and insure their property. As consumers, when we buy insurance, we accept that insurers have more data and experience on the drivers of our risk than we do ourselves. Yet large corporations, with billions of dollars of insured property values, across large portfolios, are increasingly aware they too can amass and integrate large datasets about their exposures; and that they too can equip themselves with tools to quantify their own risks, including from catastrophes. In fact, many large corporations, who develop, operate and maintain their own assets have at their disposal more knowledge of the detailed drivers of their exposures than their insurers do.
The science of climate and its impact on property is far more robust than even a few years ago, and it is becoming more actionable via a growing ecosystem of private firms and open/public-domain sources.
Leading insurers are also taking measures to open their own insights and expertise to their customers, empowering them to make more proactive decisions.
Empowered with these data-driven insights, leading corporations are taking control of their view of risk. They are shifting from a mindset of “buying insurance” and deferring to the insurance markets for pricing, to one in which they are “selling their risk,” if and only if it’s optimal to do so. This requires a proactive approach, an understanding of your total cost of risk, a readiness to retain more risk and a willingness to invest in resiliency strategies to mitigate and reduce risk.
An illustration of a shift in this paradigm is a growing number of companies that are complementing their traditional property insurance programs with innovative alternative risk transfer strategies, such as the use of catastrophe bonds. In 2021, it was reported that companies as diverse as Prologis, Blackstone and Google all issued catastrophe bonds to ‘sell” a portion of their U.S. catastrophe risk into the capital markets. As summed up by Artemis, “When large corporations look at catastrophe bonds it is typically because the traditional insurance market either cannot service their needs, or is too expensive, at certain levels of loss and exposure. Being able to identify exactly where the capital markets could provide a more efficient source of insurance, is critical and today, with the explosion of new tools to help ceding companies better understand their risk exposures, that is becoming an easier task.”
A more volatile world is already upon us, and these trends will accelerate as the consequences of climate change manifest in more frequent extreme weather events. “Buying insurance” is no longer enough to ensure the resiliency of the buildings and infrastructure that powers our economy. Business leaders are taking an “all of the above” approach that integrates traditional insurance with alternative ways to define and “sell risk” (such as cat bonds) alongside proactive risk retention, resiliency, and mitigation-driven strategies for asset management and property operations.
This is what’s required, now, more than ever.
Written by Hemant Shah Shah is the CEO of Archipelago, an AI technology and data analytics company. He co-founded Risk Management Solutions (RMS), a risk modeling firm serving the global insurance industry. He is passionate about risk and resiliency, and serves on the Board of the social venture, Build Change.