Reinsurance companies are often described as the insurer of insurance companies, a simple but accurate definition for what they do. Some risks are just too large and undiversified for an insurance company to bear, so the insurer will look for reinsurer to share this risk. In practice, the insurer and the reinsurer share the revenues from the premiums of the insurance policies sold, and will share the expenses of eventual benefits or reimbursements that will need to be paid to policy holders.
Munich Re is one of the top 2 global reinsurance companies in the world, with revenues of €27.8 billion in 2016[i]. The profits of reinsurance companies arise from the difference between the premiums they earn and the claims they must pay. One of the reasons why insurers look for the services of Munich Re is to share the risk associated to the protection of property and lives against the damage caused by natural catastrophes. In fact, nowadays global reinsurance companies pay the larger share for catastrophic claims[ii], which makes them a critical step in the supply chain of insurance against natural catastrophes. Without reinsurers, insurance against natural catastrophes is not possible. Munich Re has helped to pay for the damages of the 1906 San Francisco earthquake and fire[iii] and of Hurricane Hugo in 1989[iv].
The ability to accurately price risk is a core capability for every reinsurance company. In fact, the ability of estimating and pricing risk of natural catastrophes is what enables Munich RE to offer its services at a price at which they can profit but is still make the investment worth for their customer – the primary insurer.
If the frequency of natural disasters keeps increasing at a predictable pace, Munich Re will increase its price in order to compensate for the higher risks.
If that happens, presumably there will come a point when prices will be so high that revenues of Munich Re will start to decrease because less costumers will be able to afford coverage or will have interest to do so, but reinsurance, and hence insurance, would still be supplied.
However, the situation could be much worse if natural catastrophes start to increase in an unpredictable pattern. The consequence of inaccurately pricing the risk of natural disasters is that the company could have unexpected losses as the revenue received from the premiums in exchange for coverage are not enough to off-set the expenses with claims from end customers. One might argue that this unpredictable trend has already began: in the period between 2012 and 2015, Munich Re (reinsurance division) spent €686 million a year to help recover properties damages by natural catastrophes[vii], but in the third quarter of 2016, RE Munich announced to shareholders that it would decrease its results outlook for the year by due to higher than expected losses caused by hurricanes Harvey, Irma and Maria.[viii] Comparable expenses in 2016 were €929 million.
To cope with the additional risk brought by climate change, Munich Re has established a research institution called Corporate Climate Center (CCI) that has been studying climate change and its consequences since 1974. Researchers of CCI have reported that Munich Re will be capable of confidently estimating the likelihood of natural catastrophes until 2050, but if measures are not taken to reduce the emission of CO2, the risk of natural disasters will become impossible to predict and assets will become uninsurable.[ix] In fact, the difference between the costs of natural disasters and the amount insured – the so-called “protection gap” – has gone from 63% in 2012 to 72% in 2016.[x]
Munich Re is arguably the best positioned institutions in the world to predict natural disasters. They have the best data and the right incentives and resources to do so. As such, they should take a more active role in influencing governments and regulations to incentivize more drastic measure to reduce the carbon emissions.
What other actions should Munich Re take to reduce the protection gap and ensure the supply and profitability of natural catastrophes insurance in future decades.
[i] Munich RE, 2016 Preliminary Financial Statements, [https://www.munichre.com/site/corporate/get/params_E1386298429_Dattachment/1373399/MunichRe-IR-Preliminary-financial-statements-2016.pdf], accessed November 2017
[ii] McKinsey & Company, “Global reinsurance: Fit for the future”, September 2017 [https://www.mckinsey.com/industries/financial-services/our-insights/global-reinsurance-fit-for-the-future]
[iii] Munich RE, “Group History” https://www.munichre.com/en/group/company/history/early-years/index.html, accessed November 2017
[iv] Munich RE, “Group History” https://www.munichre.com/en/group/company/history/new-era/index.html, accessed November 2017
[v] University of Cambridge, “Cambridge Institute for Sustainability Leadership – ClimateWise launches two reports that warn of growing protection gap due to rising impact of climate risks” https://www.cisl.cam.ac.uk/business-action/sustainable-finance/climatewise/news/insurance-leaders-warn-protection-gap-due-to-impact-climate-risks, accessed November 2017
[vi] Munich Re, “Nat Cat Database” http://natcatservice.munichre.com/events/1?filter=eyJ5ZWFyRnJvbSI6MTk4MCwieWVhclRvIjoyMDE2fQ%3D%3D&type=1 accessed November 2017
[vii] Munich RE, “Key Figures” https://www.munichre.com/en/ir/annual-report-2016/key-figures/index.html
accessed November 2017
[viii] Munich RE, “Press Release” https://www.munichre.com/en/media-relations/publications/press-releases/2017/2017-10-26-press-release/index.html accessed November 2017
[ix] New Republic https://newrepublic.com/article/123212/who-will-pay-climate-change accessed November 2017
[x] Munich Re, “Nat Cat Database” http://natcatservice.munichre.com/events/1?filter=eyJ5ZWFyRnJvbSI6MTk4MCwieWVhclRvIjoyMDE2fQ%3D%3D&type=1 accessed November 2017