Lloyd’s: Extreme weather events can be modelled as independent

Lloyd’s has published a new study that supports the case that extreme weather events can be modelled as “independent” by global reinsurers when assessing many of their key aggregate risks around the world.

The report, 'The Risk of Global Weather Teleconnections', carried out with the Met Office, analyses the links between extreme weather events occurring in separate regions of the world that can take place over a range of timescales from days to years.

Met Office research found that the majority of perils are not significantly correlated, but identified nine noteworthy peril-to-peril teleconnections, most of which are negatively correlated. Lloyd’s’ modelling found that these correlations were not substantial enough to warrant changes to the amount of capital it holds to cover extreme weather claims. Even when there is some correlation between weather patterns, it does not necessarily follow that there will be large insurance losses.

The study says extreme weather events may still occur simultaneously even if there is no link between them, therefore an assumption of independence for capital-holding purposes is appropriate for the key risks the Lloyd’s market currently insures.

The methodology released in the report enables scenario modelling across global portfolios for appropriate region-perils.

Trevor Maynard, head of Exposure Management & Reinsurance at Lloyd’s said the report’s findings go a long way to answering the challenge that capital for local risks should be held in their own jurisdictions. “Lloyd’s believes this approach reduces the capital efficiency of the re/insurance market by overlooking the heart of insurance and the diversification benefits provided by writing different risks in different locations, and in doing so, needlessly increase costs to the ultimate detriment of policyholders. Insisting on the fragmentation of capital is not in the best interest of policyholders,” he said.

Professor Dame Julia Slingo, chief scientist at the Met office, said the report demonstrates the continuous improvement in our understanding of connections between climate drivers and regional perils across the globe. “When we add this to our cutting-edge capabilities in simulating the global climate to the local weather and in deploying these for more skilful long-range predictions, we can help re/insurers model multiple, and possibly teleconnected, scenarios and more effectively manage their portfolio of risk.”

The Met Office research analysed the impact of nine (out of a pool of 22) 'earth-system drivers', such as El Niño, on 16 priority region-perils that Lloyd’s selected as the most important. Lloyd’s then ran this information through its internal model to arrive at the report’s conclusion. To enable debate and review, Lloyd’s and the Met Office have made the methodology publicly available.

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