Climate Change Is Hitting the Insurance Industry Hard. Here’s How Swiss Re Is Adapting

This post was originally published on this site

On a radiant summer day, all looks precisely right on the shore of Switzerland’s Lake Zurich, at the headquarters of global insurance behemoth Swiss Re. The postcard-perfect harbor bustles with bronzed sunbathers, dark-hulled yachts, and picnickers sipping wine. On the street alongside it, cyclists dutifully ring their handlebar bells for pedestrians, and blue-and-white city trams run on time. Inside the headquarters itself—a complex comprising a 1913 neobaroque edifice and a 2017 addition sheathed in undulating glass—art worth millions adorns white walls, coffee bars accented in leather and steel dispense mineral water in three levels of carbonation, and the employee cafeteria serves up chilled melon soup with mint, organic tofu with mango chutney, and fruit tarts and ice cream.

Yet things are anything but placid for Swiss Re, the 155-year-old corporation that, as measured by the $36.4 billion in revenue it collected from premiums in 2018, is the world’s largest “reinsurance” company. Executives anxiously are weighing the insurer’s financial exposure to some of its biggest clients. Ph.D. scientists are poring over algorithms to figure out how to cope with ballooning costs. Under intensifying pressure, they’re questioning much of what they know about assessing risk—and making decisions that could redirect billions of dollars.

Little known but crucial to commerce, reinsurers act as backstops of the global economy. They insure major multinationals, huge industrial facilities, and vast portfolios of risk that first-line insurance companies decide they need to hedge. That makes them leading indicators of the condition of capitalism—sprawling enterprises paid to ferret out and manage emerging mega-threats. Today, the threat that particularly worries Swiss Re is one that, like essentially every other company on the planet, it hasn’t figured out how to accurately quantify, let alone to combat: climate change.

For the insurance industry, global warming has advanced from a future ecological challenge to a present financial shock. Together, total losses to the economy from natural catastrophes and “man-made disasters” reached $165 billion in 2018; that followed a 2017 that, at $350 billion, cost more than twice as much. As a result, according to the Swiss Re Institute, the company’s research arm, 2017 and 2018 were for insurers the most-expensive two-year period of such catastrophes on record, requiring them to fork over $219 billion globally in checks. The majority of the insurers’ 2018 payouts were in North America, triggered by wildfires, thunderstorms, and hurricanes. The economic impact from catastrophes in 2018 alone was “shocking,” Christian Mumenthaler, Swiss Re’s chief executive, told shareholders this past March, in the company’s 2018 annual report. And Swiss Re is convinced, Mumenthaler made clear, that the trend is linked to rising temperatures: “What we’ve experienced over the past year must serve as a wake-up call to stand together in unity and step up our efforts against climate change.” 

Subscribe to The Loop, a weekly look at the revolutions in energy, tech, and sustainability.

Ups and downs are old hat to the insurance industry. Over the past two decades, Swiss Re’s natural-catastrophe business has collected more than twice as much in premiums as it has had to spend in payouts. The company’s stock price is robust, and rating agencies generally give Swiss Re high marks. But a potentially worrying trend is developing: For the past two years, Swiss Re has had to pay out vastly more for large natural catastrophes, those over $20 million apiece, than its models anticipated for an average year’s loss. In 2017, Swiss Re expected to incur $1.18 billion in large “nat-cat” losses, based on actuarial averages, but racked up a bill of $3.65 billion. In 2018 it anticipated a $1.15 billion hit but had to absorb $1.9 billion. The biggest single blow that year came from hurricanes—the intense storms that originate in the North Atlantic and Northeastern Pacific. The question is whether this is a rough patch of the sort Swiss Re has absorbed before, or the start of a long-term rise in losses triggered by climate change.  

Now the insurer is undertaking a corporate repair job designed to insulate its profits from the heat. Believing that the profitability of coal is on the wane, it’s pulling back from insuring and investing in companies that mine or burn the black rock—a retrenchment that has some of its blue-chip clients fuming. Worried that the complex mathematical models it uses to predict and then “price” coverage for natural-disaster risks need serious rethinking to account for a warming world, Swiss Re is scrambling to improve them. These are potentially pivotal fixes that could have sweeping consequences for business. But each is in its nascent stages, and each is proving maddeningly hard. 

One morning this summer, I find myself in a conference room in Swiss Re’s complex in Zurich, sitting across a table from Thierry Corti, a lanky Ph.D. climate scientist who works as the company’s head of sustainability-risk management. “We think day and night about what can go terribly wrong in this world,” he tells me. But climate change, he says, “might be the problem that humanity is not clever enough to really tackle.” As if as an omen, my visit marks the start of a weeklong heat wave that will shatter temperature records across Switzerland and Europe.

Throughout the financial sector, leading players, from banks to pension funds to insurers, are deciding they could lose big from climate change. Broadly, they cite two threats to capital in a warming world. 

One, “transition risk,” is the specter that the value of massive sunk investments could shrivel, as regulators and investors get serious about slashing carbon emissions. The profitability of fossil-fueled power plants, of coal mines and oilfields, of factories that make internal-­combustion-powered cars—and of the companies behind these assets—could plummet as society decarbonizes. If the shift reached meaningful scale, trillions of dollars worth of infrastructure could lose value, devolving into what investors call “stranded assets.” 

There are signs this already is happening. Coal stocks have tanked, in large part because of the increasing cost-competitiveness of lower-carbon fuels: The Dow Jones U.S. Coal Index is down 95% from its 2011 peak. In January, the CRO Forum, a Netherlands-based organization of chief risk officers of big insurers, warned of new sorts of climate-related claims that may confront insurers. Among them: hefty bills from corporations they insure against lawsuits. At this point, legal action charging that big carbon emitters contributed to climate change or failed to react sufficiently to it is just beginning to emerge. But, as the insurance group noted ominously, the science of pinning climate blame on corporate polluters “is developing fast.”

Swiss Re’s lakefront headquarters in Zurich.
Christian Beutler—KEYSTONE/Redux

The other threat is “physical risk”: that warming temperatures could trigger enough sea-level rise, storm intensification, and drought-fueled wildfires to wipe vast sums off corporate balance sheets. A Swiss Re Institute chart tracing damage from recent threats looks like ascending peaks in the Alps: Hurricane Sandy in New York in 2012, Hurricane Harvey in Texas and Louisiana in 2017, and the apocalyptic California fires of 2018. (See the graphic below.) By mid-century, observers say, the damage could make what has emerged so far look quaint. In the U.S., the CRO Forum declared, some coastal and forest-fringe areas “are already on the edge of uninsurability.” 

Such worries are spurring some of the global economy’s biggest players to act. This year alone, Norway’s sovereign-wealth fund, the world’s largest, said it’s divesting its holdings in pure-play oil-and-gas exploration and production companies, and the Bank of England asked U.K. insurers to assess how climate change might affect their returns. In the past couple of years, many of the world’s biggest insurers and reinsurers—among them Germany’s Allianz and Munich Re, France’s AXA and SCOR, and Chubb, whose biggest market is the U.S.—have announced they are pulling back their coal exposure, either in their investments, their insurance books, or both. Few, though, are taking steps as deep as Swiss Re. Whether those steps end up protecting Swiss Re from cataclysmic exposure, as the company hopes, or handing chunks of its market share to less-climate-concerned rivals, as some executives admit they fear, will depend on how skillfully Swiss Re negotiates this transition.

Death and destruction are Swiss Re’s bread and butter. But what the company finds existentially worrisome about climate change, says J. Eric Smith, Swiss Re’s Americas chief, is that, as the world warms, the company’s “ability to predict frequency” in assessing the future flow of mayhem “is becoming a little shaky.” Smith describes discussions he has had with his fellow executives: “What we say in private is, ‘My gosh, we’ve had two bad years, and now we’re going to have a third bad year?’ ” The crush of intense hurricanes is “ just not right. It’s just not normal that this is happening year after year.”

Swiss Re’s resolve to confront climate change intensified after the 2015 Paris climate conference, the international gathering at which most countries made voluntary pledges to stanch their emissions enough to prevent average global temperatures from jumping more than two degrees Celsius above preindustrial levels. That’s the threshold beyond which, most scientists say, climate change would have particularly dangerous effects.

Like many big companies, Swiss Re signed a similar voluntary pledge. That in turn triggered a decision inside the company to analyze the way its investments and its insurance decisions were facilitating the financing of carbon-intensive infrastructure. It wasn’t long, Corti recalls, before support for coal emerged as “the hotspot—the elephant in the room.”

Swiss Re’s initial move was a relative no-brainer: dialing back the money it invested in companies that mine and burn power-related coal. Swiss Re, like insurance companies generally, is a large investor; it parks premium revenue in various assets to earn money to finance future payouts. In 2016, Swiss Re began pulling its investments in mining companies that derive more than 30% of their revenue from coal and from power companies for which coal represented more than 30% of their generation capacity. The investments snagged by that screen have amounted to only $1.3 billion, or about 1% of Swiss Re’s $132 billion investment portfolio. But Swiss Re saw it as a first step in shifting its assets to lower-carbon sectors—a matter not just of environmental benefit but, more important, of financial prudence, with renewable energy getting cheaper and making coal less competitive.

Swiss Re’s next move was more controversial within the firm because it involved the core of its business—deciding whom it would and wouldn’t cover in the first place. After internal debate, Swiss Re began in July 2018 to decline to insure pools of risk with “exposure” to coal that exceeded 30%. Underneath that catchall word was some important fine print: Swiss Re would apply the restriction not to the whole company that was applying for coverage but only to the specific property that that company wanted Swiss Re to insure or reinsure. 

“What we say in private is, ‘My gosh, we’ve had two bad years, and now we’re going to have a third bad year?’ [It’s] just not right. It’s just not normal that this is happening year after year.”

That narrower exclusion would cause “less collateral damage,” explains Lasse Wallquist, senior sustainability-risk manager at Swiss Re. The company could sell insurance even to coal-heavy firms—as long as what those firms wanted Swiss Re to insure wasn’t itself coal-heavy. “We would insure the biggest coal company ever,” Wallquist notes, if that company wanted Swiss Re to cover “a solar plant.” The percentage of premium income that it sacrificed to this decision was, Wallquist says, “low.” 

However small the sums involved may be, Swiss Re’s moves have struck both fans and foes as a big deal. To climate campaigners keen to asphyxiate the already-ailing coal industry by pushing financiers to cut off its supply of money, the decision by the world’s biggest reinsurer to begin pulling the plug is a pivotal win. Says Kuba Gogolewski, an anti-coal activist in Poland, which still generates about 80% of its electricity from coal: “When you look at where climate change can be tackled, it’s actually reinsurance—and reinsurance in the most-developed countries —where we have the most leverage.”

Swiss Re doesn’t disclose companies or insurers from which it pulled back coverage as a result of its coal policy, and it declined to comment for this story on any names. But, based on Gogolewski’s research, it appears that Swiss Re stopped reinsuring at least a portion of the book of PZU, a big Polish insurer with lots of coal exposure. PZU’s annual reports list the top three to five “partners” providing PZU with reinsurance; those reports included Swiss Re on that list in 2015 and 2016 but not in 2017. PZU says that Swiss Re today remains among PZU’s top 10 reinsurers, and declined to comment as to whether Swiss Re pulled back any of its coverage.

Swiss Re’s move clearly is problematic to coal-reliant companies whose policies the insurer has cut off. Among those companies is American Electric Power, one of the biggest coal burners and electricity producers in the U.S. Swiss Re was part of a consortium covering AEP’s roughly $750 million in insured property, much of which comprises power plants; Swiss Re had covered about 3% of that risk, AEP says. But in May, the insurer notified the utility, based in Columbus, Ohio, that it would decline to renew the policy, effective this past July 1, because more than 30% of the power generated by the assets came from coal, says Julie Sloat, AEP’s senior vice president for treasury and risk. AEP says other insurers filled the breach and didn’t increase AEP’s premiums. But Sloat says the insurance industry’s rising resistance to coal is “something we really keep a watchful eye on.” 

AEP, like many power generators, has pledged to dial down its carbon emissions. The portion of AEP’s power-generating capacity that comes from coal was 66% in 1999, has fallen to 45% today, and will drop to 27% in 2030, Sloat says, and these days “you don’t see us invest in—other than maybe maintenance—any coal-based anything.” 

Sloat says Swiss Re should judge AEP’s exposure to coal not on existing plants but by the new infrastructure AEP is building. By pulling out, she says, Swiss Re is relinquishing the leverage it had to prod the company toward bigger change. “To the extent that we have insurers that are our partners, my goodness, they have a big voice,” Sloat says, calling Swiss Re’s approach “the wrong path.”

Yet Swiss Re is turning up the pressure. In September it announced it’s tightening its screen on coal investment, adopting an absolute cap on the exposure it will tolerate from companies in which it invests. It said it will divest from mining companies that produce at least 20 million tons of coal per year and from power generators with more than 10 gigawatts of coal-fired capacity. Swiss Re also announced an even more ambitious goal: By 2050, it says, both its investment portfolio and its insurance book will be carbon-neutral, meaning those holdings will remove as much carbon from the air as they put into it.

Swiss Re’s coal pullback amounts to a parry intended to preserve the finances of the realm. Its push to shore up its hurricane models represents something else: a full-body-armor campaign to defend its crown jewels. The nemesis: Mother Nature, who’s growing increasingly unstable.

Swiss Re’s spike in bills for large nat-cat payouts sounds loud alarms at a company that prides itself on having perhaps the most sophisticated disaster-modeling operation in the business. Martin Bertogg, a natty dresser and straight talker who has worked at Swiss Re for two decades, oversees what the company calls catastrophe perils. The effort seeks to anticipate trends in a biblical list of disasters that, in addition to hurricanes, includes earthquakes, tornadoes, hail, and floods. “If you have a rational approach,” one that allows you to understand the climate’s vicissitudes “better than your competitors, you can be profitable,” Bertogg tells me.

Dozens of models spin out of Swiss Re’s shop, each for a different kind of disaster in a different part of the world. By far the most financially important one is for hurricanes. From refinery complexes along the Gulf of Mexico, to beach condos in Miami, to the global financial nerve center of lower Manhattan, trillions of dollars in infrastructure lie in the path of increasingly violent storms, pressuring Swiss Re to continually reassess which properties it can profitably reinsure, and at what price.

Martin Bertogg heads the insurer’s efforts to use computer models to predict and prepare for natural disasters.
Courtesy of Swiss Re

So far, the hit to Swiss Re’s bottom line that can definitively be chalked up to climate change remains small. In part that’s because its property policies typically last only a year, giving the company a chance to raise rates as its models detect rising dangers. But by mid-century, Swiss Re has come to believe, climate change will be a major driver of increased risks and losses—which is why the company feels so under the gun to climate-proof its models. 

Right now, Swiss Re’s analysts have high confidence that events that result directly from higher temperatures—sea-level rise, for instance, and also storm surges and landslides—will increase as a result of climate change. But a worsening of catastrophes whose relationship to climate change is indirect—including hurricanes, whose behavior depends on the way that higher temperatures interact with complex systems in the oceans and the atmosphere—is “really in a low-confidence area,” explains Michael Gloor, an expert in atmospheric physics who’s on the modeling team. The disasters that tend to cost Swiss Re the most, in other words, are precisely the sorts whose trajectory it is least able to divine.

Modeling hurricanes isn’t brain surgery. But to the uninitiated, it can seem pretty close. To try to understand it, I join Gloor in a sun-drenched conference room overlooking Lake Zurich. Like Corti and Bertogg, he studied at ETH Zurich, a renowned science university in town. 

In most insurance models, past is prologue. They extrapolate from the behavior of previous storms to predict the path, fury, and, thus, cost of future ones. That’s the actuarial worldview: an assumption that, on average, tomorrow will be essentially like today. To start the process, modelers input into their computers publicly available data on the trajectory of previous hurricanes. Then they write code that causes the model to alter the behavior of that hurricane both based on how other prior storms in that part of the world have played out and by moving around the actual storm’s trajectory randomly, based on knowledge of how hurricanes typically behave. For each actual hurricane they analyze, the model spits out perhaps 100 or 200 theoretical variants of the storm in question. 

An AEP power plant in Winfield. W. Va. Swiss Re Stopped insuring AEP property this year because of the utility’s reliance on coal.
Luke Sharrett—Bloomberg via Getty Images

Graphed on a screen, the actual hurricane appears as a red line, which Swiss Re calls “the mother.” Each of the theoretical variants appears as a black line—called “the daughters,” and also “spaghettis,” because they vaguely resemble thin strings of pasta. As Gloor flips through the model of Hurricane Maria, which in 2017 wreaked havoc on Dominica, Puerto Rico, and the U.S. Virgin Islands, he stops on one screen of code. “Create some spaghettis with empty intensity measures,” says a note from one of the modelers.

For each spaghetti, the model creates a track of the area likely to be impacted by the hurricane’s winds­—a track known as a “wind field.” It also adjusts the frequency with which it expects hurricanes to strike based on sea-surface temperatures. Then it combines that data with another trove of information, this one quantifying the value of insured property in a potential client’s portfolio. From that comes what Swiss Re really cares about: a curve showing the likelihood that, in each of a number of geographic swathes, a hurricane strike will produce a given amount of insured loss. The company uses these “loss frequency curves” to calculate a premium price that—according to the model—will both cover the expected payout and deliver an acceptable profit. 

Swiss Re’s storm modeling today has the same basic goal today that it did a generation ago: “to build the spaghettis,” Gloor tells me, “in a way that they reflect the current climate.” 

What modelers now are reckoning with, however, is the likelihood that climate change will produce a future very different from the past.

Swiss Re has struggled for years to adapt its modeling to a warming world. Initially it built into its models an assumption that climate change would produce a 1% yearly increase in storms. 1% yearly increase in the frequency of European wind storms. Later it stopped that practice, concluding the science wasn’t clear enough to justify it. Instead, it added a dial that factors in the way sea-surface temperature impacts hurricane frequency, a factor it still uses today. But the recent surge in the cost of disasters, particularly hurricanes, has underscored the need to find a better way. 

Now Swiss Re is helping to fund, on the other side of the storm-prone Atlantic, work on a new model it hopes really will be climate-smart. In New York City’s Morningside Heights neighborhood, at the applied-mathematics and applied-physics department of the engineering school of Columbia University, a team led by a former trumpeter and current atmospheric scientist named Adam Sobel is working to refine it. Rather than extrapolating from storms that occurred when times were cooler, they’re deploying vast computing power to create “synthetic” storms that—so the modelers hope—will better reflect the realities of an era that’s getting hot.

The synthetic-storm methodology that Sobel’s team uses was pioneered by Kerry Emanuel, a hurricane expert at MIT. The Columbia crew’s secret sauce is the model it has written, which incorporates particular assumptions about the physics of how climate change will affect hurricanes. Rather than employing Swiss Re’s current standard, a top-down approach that starts with the paths of past hurricanes and, as Sobel puts it, uses historical data to “just jiggle it a little bit,” the Columbia modelers use a bottom-up method, starting with data on weather-related factors they think are both relevant to hurricanes and likely to be influenced by global warming. Among those factors: “wind shear,” which is the variation in wind speed and direction at different altitudes; sea-surface temperature; and the amount of moisture in the air. Using that data, their algorithm calculates when a hurricane will form, how it will move, and how intense it will be. Theoretically, this more-forward-looking approach could be more accurate.


So far, uncertainty about which assumptions are the right ones is causing the model to disgorge contradictory conclusions. One key question concerns the interplay between rising temperatures and moisture. Because higher temperatures stuff more ocean moisture into the air, scientists generally agree that climate change will make hurricanes more intense. Many have come to believe the wetter air will make hurricanes more frequent too.

But warmer temperatures don’t just increase the amount of water in the air; they also increase the amount of water the air can hold. And the Columbia scientists have found that their models spit out differing results depending on which of two moisture metrics they feed the algorithms. Using one, “relative humidity,” which is the ratio of the amount of water the air is holding to the amount it is capable of holding, the models say climate change makes hurricanes more frequent. But using another metric, the “saturation deficit,” which is the absolute difference between the amount of water the air is capable of holding and the amount it’s holding, the models say climate change makes hurricanes less frequent. Warmer oceans affect both those metrics—and leave scientists to debate which matters more.

Chia-Ting Lee and Adam Sobel of Columbia University are working to refine Swiss Re’s Climate prediction models and reaching some contradictory conclusions as they do so.
Photograph by Hilary Swift for Fortune

“We sort of convinced ourselves that saturation deficit was better” as a storm indicator, Sobel tells me late one afternoon in his windowless office, one of its white-painted cinder-block walls hung with a bright abstract representation of a hurricane’s movement that his mother painted for him. “But we don’t know that,” he confesses. In a scientific paper now under review, he and his colleagues admit that, according to their model, whether climate change makes hurricanes more or less frequent depends on which moisture metric a modeler chooses to emphasize. “We would almost be embarrassed about putting this result out there,” Sobel says. “The thing that makes us less uncomfortable is that this is the state of knowledge in the industry.”

Which raises a costly dilemma for players with real money on the line. “The question,” notes Chia-Ying Lee, a Columbia faculty colleague of Sobel’s who has led the team’s modeling work, “is, with one saying ‘more’ and one saying ‘less,’ which to believe?”

Back in Zurich, Bertogg, the Swiss Re catastrophe chief, would love to know. “I was hoping,” he says, exuding Swiss diplomatic restraint, “for a bit more clarity.” In light of the Columbia team’s results, he says, the insurer plans to tweak its models to “add more uncertainty” about hurricane frequency. Meanwhile, the company will keep searching for more understanding.

Such is life for Swiss Re as it scrambles to understand how global warming will affect its profits—and to understand it specifically enough to help it redirect its business. Ultimately, the same strategic conundrum faces all corporations, as it does their investors and regulators. But, as the weather vane of the global economy, the insurance industry finds itself spinning first, trying to calculate how the warming, shifting winds will buffet its bottom line. 

On the morning I visit Smith, Swiss Re’s Americas chief, the weather is gorgeous. The view out the windows of his art-filled office in Armonk, N.Y.—a view framing grass, trees, and a reservoir—is sublime. But the air is thick with thoughts of Hurricane Dorian, which has just finished walloping the Bahamas, 1,130 miles to the south. By the time the storm petered out, it generated damage that, according to an estimate from risk-analysis firm AIR Worldwide, cost insurers between $1.5 billion and $3 billion.

Dorian might have walloped Swiss Re’s coffers harder, had the storm not dissipated as it did. “So far, this isn’t a bad year,” Smith tells me, sitting in the air conditioning and breathing a sigh of relief. There are, of course, a few months yet to go.

A version of this article appears in the November 2019 issue of Fortune with the headline “Racing a Rising Tide.

More must-read stories from Fortune:

—The 2019 Fortune Future 50: See which companies made the list
Businesses are balancing tomorrow’s opportunity and today’s capacity
—How Big Tobacco could fill the void if vaping goes up in smoke
—Spotify saved the music industry. Now what?
—Inside James Dyson’s costly decision to kill his electric car
Follow Fortune on Flipboard to stay up-to-date on the latest news and analysis.

Add Comment