Economic and demographic factors driving loss costs: Plenum
Insured losses from major disasters are being driven higher by economic and demographic factors, while at the same time the observed frequency of major catastrophe events has not been seen to increase, according to Plenum Investments.
The catastrophe bond and insurance-linked investments fund manager from Zurich explained that overall the probability of major hurricanes occurring remains low.
While hurricane Ian has been a wake-up-call to the industry, Plenum highlights the long-term performance of its UCITS catastrophe bond fund, which has delivered a compound annual growth rate (CAGR) ranging from 2% to 2.9% (USD, net of expenses) since its launch in 2010.
The Plenum Cat Bond Fund now features 101 globally diversified risk positions in its portfolio, with an average expected loss of 1.78% and offering a gross return over the money market of 4.48%.
Commenting on how the frequency of large natural disasters has changed, Plenum explained that, “A look at the history of events over the past 40 years shows an increase in natural catastrophes in the period 1980 to 1995, with the frequency of earthquakes remaining virtually unchanged and the number of storm and flood events increasing during this period.
“Contrary to the general perception, however, there has been no continued increase in the frequency of natural disasters over the past 20 years.”
Adding that, “Statistically, there is no demonstrable influence of climate change on natural disasters.”
However, growth is driving losses higher still, which is one factor now being widely realised in reinsurance and ILS markets as inflation gets priced into their renewal contracts.
Despite the lack of statistical evidence for increased catastrophe event frequency, Plenum said, “Financial losses from catastrophic events have increased massively and are growing exponentially. This is due to the increase in insured values in exposed regions.”
“With the increase in population density in coastal regions, the probability of natural events causing greater insured losses has risen. Economic and demographic factors are key drivers of higher insured losses,” the investment manager also said.
With significant hurricane events of particular note to the catastrophe bond market, Plenum said that currently the higher losses suffered are being factored into the risk models the industry uses.
“Recent model adjustments that take this into account therefore lead to higher risk ratios for reinsurers and higher insurance costs,” Plenum said.
Dirk Schmelzer, Partner and Senior Portfolio Manager at Plenum Investments AG, explained, “Observation of historical events is not sufficient to calculate hurricane risk. It does not capture changes in settlement or insured values, nor would changing construction methods or building codes be reflected in the measured risk.
“So the largest component of the new risk models is demographic and economic in origin.”
Hurricane Ian could be another example of these economic and demographic trends, given the high-value coastal homes that have been destroyed and the evident asset values impacted by the storm along Florida’s west coast which has been getting increasingly populated.
Plenum highlighted the role of catastrophe bonds as a diversifier for investors and noted that, when it comes to these rising loss costs from relatively infrequent major events, “These are compensated for by reinsurance premiums over the further course of time. Losses only occur in the event of major natural catastrophes, while smaller events do not cause price fluctuations.”
Of course, that depends on the strategy, as some higher-risk ILS and cat bond fund strategies have experienced repeat negative years of late, as the lower-down in reinsurance towers they operate, the more exposed to event frequency some have become.
