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Climate change will offer long-term tailwinds: Goldman Sachs

4th February 2022 - Author: Katie Baker

Analysts at Goldman Sachs believe that the London Market and re/insurance stocks are debating whether companies are pricing correctly for the increased cost of weather losses due to climate change, or whether companies are basing pricing on historical trends.

Goldman-SachsAccording to analysts, the market is also questioning whether or not companies have been conservative enough in their catastrophe budgets, or whether they are basing these estimates on previous trends which has lead to estimates being behind the curve, and ultimately increasing the probability of disappointing earnings.

Goldman Sachs believes that any increase in companies’ cat budgets would be positive, even if they believe them to be conservative.

Although this could potentially lead to short-term earnings estimate declines although it would improve long-term market confidence.

Analysts believe this could start to have capital consequences, with S&P recently publishing a report suggesting they are now looking at natural catastrophe losses relative to budgets.

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Despite S&P’s report, Goldman Sachs believes that climate change likely to drive higher weather losses, leading to a material tailwind to the sector, which will ultimately increase both demand for property insurance and property reinsurance and the price of insurance and reinsurance.

The analysts noted that insurance and reinsurance pricing can be changed every 12 months, and if weather losses continue to increase, then the re/insurers can increase pricing every year in response to this.

Analysts noted that property re/insurance is a short-tailed business and hence if the reinsurers are mispricing, they know and can react very quickly. In their view, it is clear that weather losses have increased, and indeed data from the Insurance Information Institute (III) in the US clearly shows that the level of catastrophe losses has continued to rise each decade.

Furthermore, both the severity and frequency have been increasing, with 2017 becoming a record year for US weather losses in terms of absolute cost, while 2020 was a record year in terms of the number of $1bn+ events.

Last year was also similar, as Swiss Re estimates that global insured losses from catastrophes was $105bn, the fourth highest on record.

Man-made disasters triggered another $7bn of insured losses, resulting in estimated global insured losses of $112bn compared to the ten-year average of $86bn and 2020 losses of $99bn.

Hurricane IDA led to c.$30bn+ of insured losses and was the second-most damaging and intense hurricane to make landfall in the US state of Louisiana on record, behind Hurricane Katrina.

Analysts further explained that the remnants of the storm also caused widespread flooding across the Northeastern United States. However, winter storm Uri and other secondary peril events caused more than half of the total losses.

While the two biggest losses were from the US, international (non-US) catastrophe losses were also much higher, with industry expert Cresta CLIX estimating that accumulated losses from $1bn+ events were $21.6bn in 2021, well above the long-term average of $17.2bn.

The July 2021 European floods – the costliest natural catastrophe event in German history – was over half of this number with the loss now expected to be c.$12bn.

Swiss Re has also reported estimates that rising catastrophe losses could translate to $149bn to $183bn of new global property premiums by 2040, this will bode well for property insurers and particularly the reinsurers.

This increase in demand would not only drive the top line of reinsurers over the next 20 years, but would drive pricing higher too with the current supply of capital likely to struggle to meet this increased demand.

The analysts concluded that whilst climate change is likely to offer a material tailwind to property insurance demand, both underlying economic growth and urbanisation should also drive demand.

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