Plataforma sobre Adaptación al Cambio Climático en España

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Coverage of extraordinary risks derivables from climate change

Autor: Francisco Solano Espejo Gil/Fototeca CENEAM

Insurance is crucial to adapt to the risks of climate change and its consequences, which often result in natural catastrophes and extreme hydrometeorological events, directly affecting the insurance sector. In this context, the industry must adopt measures to assess risk changes. It must manage and seek solutions that minimise damage, strengthen society's resilience, and play a key role in mitigating climate change.

Spain, which has a notable insurance penetration, has a coverage system for extraordinary risks that covers the main hydrometeorological risks. This system, established by law and administered by the Insurance Compensation Consortium (CCS), is essential to increase stability and protect policyholders. The collaboration of the private insurance sector is essential for its operation. This coverage puts us in an advantageous position to face the insurance challenge presented by climate change.

 

Case Study Description
Challenges: 

 

Climate change can have a significant impact on the insurance sector. In Europe, according to reports by the International Panel on Climate Change (IPCC) and the European Union (EU) itself, the most likely risks include:

  • the increase in the duration and frequency of heat waves is significant in cities (heat islands)
  • increased incidence of droughts, Risk of forest fires, soil degradation and land displacements in semi-arid regions such as the Mediterranean basin
  • reduction in average annual rainfall and increase in torrential rains, with flooding of land and localities due to accumulation or runoff of water (rainwater, snowmelt or overflows)
  • coastal flooding due to average sea level rise, with damage to infrastructure and loss of soil due to salinization
  • more significant strong winds with occasional effects in northern areas, relatively decreasing in southern areas.
  • the increase in the frequency and intensity of other smaller-scale phenomena

Under these conditions, the expected increase in losses due to weather conditions may potentially damage insurance companies' solvency by preventing them from adjusting their risk management or entailing an increase in premiums that reduces insurance and ultimately makes it unviable, making it probably necessary to increase capital to cover losses in the future.

In this sense, the impacts of climate change on the insurance sector can pose three types of risks to be faced:

  • Physical risks arising directly from the events that have occurred and the related impacts (damage to people or property, interruption of production chains, loss of profits, scarcity of resources, etc.);
  • Financial risks of transition to a lower-carbon economy, translated into the re-evaluation of companies and goods that make intensive use of carbon and the speed with which it occurs;
  • Liability risks result from claims by parties harmed by climate change who seek compensation from others they believe to be responsible for the damages.

For all these reasons, it is essential to find solutions that allow for an adequate risk assessment so that the impacts of climate change remain insurable through probabilistic models that contemplate specific scenarios and reflect the broad spectrum of future possibilities. This would facilitate a correct diversification of extreme risks and the possibility of calculating their quantitative valuation, thus ensuring the correct provision of capital.

In addition, risk reduction depends in part on the insured themselves, which is also a fundamental element for insurance affordability. So, a major challenge is a good policy of disclosure and awareness of the possible risks arising from climate change.

On the other hand, another important challenge for the insurance sector will be to provide adaptation measures, especially those aimed at disadvantaged populations and those most impacted by the effects of global change. Many of these measures will need to be institutional and coordinated between the sector, government, institutions, and the general population, and they will probably include new economic and legislative options in the coming years that support risk reduction and insurance through policies for planning, prevention, and preparedness against extraordinary risks.

In this sense, the Spanish insurance sector has, through Extraordinary Risk Insurance, a very useful and solvent financial tool to deal with the eventuality of increased Risk and the danger of extreme and particular events as a result of climate change, increasing the resilience of people, companies, institutions, and populations.

Currently, the Insurance Compensation Consortium (CCS) covers many extraordinary risks caused by natural phenomena (floods, strong winds, etc.).

The risks considered "extraordinary" result from a dialogue between the public and private sectors, such as the CCS Board of Directors. Certain hydrometeorological risks, such as direct damage from precipitation—especially hail—or winds below 120 km/h, are covered directly by private insurers. Other risks not considered extraordinary to date, which could perhaps be considered so in the future, include the effects of heat waves on people's health or pandemics.

Objectives: 

The essential characteristic of the extraordinary risk system is the ability to automatically provide the insured with coverage against some risks considered extraordinary by mandatorily including them in the policies taken out by policyholders with the insurance companies of their choice.

This implies that the same policy offers double coverage:

  • Coverage for ordinary risks, which the insurance company bears
  • Coverage of extraordinary risks assumed by the Consorcio de Compensación de Seguros (CCS), a  public company attached to the Ministry of Economy and Business

In this sense, among the extraordinary risks caused by natural phenomena covered by the CCS are those related to flooding, sea attacks (coastal flooding), strong winds (gusts of more than 120 km/h and tornadoes), earthquakes or tidal waves, volcanic eruptions and falls of sidereal bodies and aerolites.

For this coverage, the policyholder pays a surcharge on the insured amounts, which is charged by the insurance company and its premiums, which it subsequently transfers to the CCS. Thus, the CCS acts as a direct insurer in claims caused by natural disasters of hydrometeorological origin with the most significant impact. Other hydrometeorological risks, such as hail or strong winds of less than 120 km/h, are covered directly by private insurers.

By covering such extraordinary risks, both assets (with some exceptions), personal injury and possible loss of profits occurring after an event and their valuation by experts appointed by the CCS are compensated without conditioning other valuations that the insured or the insurance company may contribute to the procedure.

Another objective of extraordinary risk insurance is to reduce damage and increase society's resilience. The CCS cooperates with competent institutions in the knowledge and management, prevention and reduction of these risks by sharing its data on compensated damages, which are essential to locate risk areas and estimate trends in the evolution of Risk, as well as in awareness and dissemination actions. These actions influence the behaviour of the insured themselves (risk awareness, self-protection measures, etc.), which can help reduce overall Risk, reduce exposure and vulnerability, and compensate for the possible increase in danger due to climate change.

Solutions: 

The transfer of Risk through insurance is in itself an adaptation measure.

Climate change can significantly impact the insurance sector, which nevertheless has an optimal tool for action to cover the risks arising from it, which has proven to be very useful and practical to date.

Despite this, considering the certainty about the possible manifestation of global change in the face of different expected spatiotemporal scenarios, forecasts point to an increase in danger, mainly regarding extreme climatic events. This means an increase in possible damages and losses in the coming years, which could, potentially and theoretically, damage the solvency of insurance companies by not being able to adjust their risk management or by entailing an increase in premiums that reduces insurance and ends up making it unviable, making it probably necessary to increase the capital to cover these possible losses.

Spain, with an insurance system based on a public-private partnership and a substantial insured base, is in a comparatively better situation than other countries around it.

However, although the Spanish hedging system has proven effective, sustainable and flexible, it is still necessary to continuously seek solutions for a correct assessment of risks in a variable and dynamic scenario of possibilities so that the effects of climate change can continue to be insurable. To this end, it is essential to know both the value of extreme risks and their possible diversification to have adequate provision of capital sectorised to hedge against them.

In this sense, although direct losses and insured losses have increased in recent decades due to hydrometeorological causes, there is a consensus that the leading cause of this increase is not the growth of danger but that of exposure derived from economic growth itself and the greater concentration of population and goods in vulnerable areas. In this way, it seems logical to act on exposure and vulnerability.

Actions outside the scope of the insurance sector, such as the improvement of early warning systems, actions on territorial planning and building regulations or the management of emergencies, directly impact this. From the point of view of insurance, continuing to offer universal and affordable coverage is the basis for the proper functioning of the system, stressing the need for insurance and that it is produced correctly for the appropriate amounts to deal with catastrophic damage. Likewise, insurance is a source of damage data that can be used to analyse risks and identify special risk areas.

From the point of view of regulation, it is important to make explicit the strategies for better adaptation to climate change. It is also important to implement education programs that raise awareness of the importance of insurance against extraordinary risks so that coverage can be designed by exposure to the risks derived from climate change and that effective resources can be available to face eventual risk Claims. This will generate added value within the framework of public policy decisions that shape and delimit the actions of the insurance activity, which affect the determination of premiums, availability of capital and capacity to deal with claims.

Apart from the extraordinary risk insurance of the Consorcio de Compensación de Seguros, from the point of view of the market, a phenomenon such as climate change opens the doors to new business opportunities on account of the new risks susceptible to coverage, although at the same time, it poses important challenges in the way in which this source of uncertainty will be incorporated in the development of the different stages of insurance and the comprehensive management of the Risk, considering:

  • Risk-based premiums can be an incentive to decrease policyholders' vulnerability.
  • The reinsurance market can be key to providing capital, which can be a potential attraction for institutional investors, for example, through catastrophe bonds.
  • Some new regulatory frameworks are needed to help increase the sector's resilience to natural disasters.

 

 

Importance and relevance of the adaptation: 

The International Panel on Climate Change (IPCC), set up in 1988 by the World Meteorological Organization and the United Nations Environment Programme, in its Sixth Assessment Report, has made it clear that:

  • The warming of the atmosphere, ocean, and land due to human influence is unequivocal. Rapid and widespread changes have occurred in the atmosphere, ocean, cryosphere, and biosphere. Climate change caused by human activities is already influencing many extreme weather and climate events in all regions of the world. There is more evidence that extreme events – such as heat waves, heavy rainfall, droughts and tropical cyclones – are changing and that evolution is due to human influence.
  • Global surface temperature will continue to rise until at least mid-century under all emissions scenarios considered. The increase in global warming of 1.5°C and 2°C will be overcome during the 21st century unless deep reductions in emissions of CO2 and other greenhouse gases are achieved in the coming decades.
  • The projected changes in extreme events are greater in terms of frequency and intensity with each additional increase in global warming

All this will cause an amplification of current risks and create new ones, with impacts that can become extremely serious and very different depending on the scenarios contemplated, being foreseeable that:

  • temperatures continue to rise
  • heat waves are more frequent and long-lasting
  • Mean sea level continues to rise
  • the acidification of its waters intensifies
  • annual rainfall decreases, and torrential rains continue to increase in Spain
  • extreme winds and associated phenomena increase

According to the World Economic Forum's "Global Risks Report" (World Economic Forum, 2019), the most important global risk today in terms of impact is the lack of mitigation and adaptation to climate change.

Regarding adaptation to climate change in Spain, which is mainly affected by its geographical location, the distribution of its wide variety of environments can likely be modified or even reduced, where appropriate. However, the system of extraordinary risks sustained by the CCS has already been tested against some scenarios of alteration of these conditions, which are variable and very different from each other, and it has given an adequate response so far.

Suppose the danger and/or frequency of some episodes changes due to climate change, and risks must be increased. In that case, the system is prepared and capable of making the corresponding adjustments to the coverage (modification of thresholds, assumption of new risks, adjustments in surcharges, etc.), always counting on constant dialogue and cooperation between the private sector and its complement for the management of extraordinary risks of the CCS.

In addition, the insurance sector itself has underlined its important role as a tool for adaptation to climate change, both directly from the distribution of risks and by using the extensive register of damage due to natural disasters that it has, providing essential information for possible studies on natural risks and their foreseeable variation with climate change

Additional Details
Stakeholder engagement: 

The different stakeholders with which the CCS interacts as an organization are fundamentally:

  • Insurance activity
  • Insured persons in their broadest sense
  • the State, owner of the public company
  • The supervisory authority
  • Other stakeholders (external collaborators, other institutions in the insurance sector, etc.)
  • Technical, scientific, and academic institutions and bodies competent in managing and knowing the risks covered.

In any case, the primary recipients of this extraordinary risk coverage are the insured and, by extension, insurance intermediaries, with whom it is essential to maintain close collaboration for the very operation and functionality of the entity and of said extraordinary risk coverage. For this reason, the CCS tries to offer them special and appropriate attention through truthful, simple and transparent information and streamlining the procedures that affect them and in which any of them intervene.

Among the channels established to serve the insured, the institutional Internet portal and the Call Center (CAT) have a remarkable impact. Both are constantly updated and aim to facilitate the insured's contact with the CCS as much as possible through a growing and gradual generalization of the automatic processes for receiving and processing queries, damage communications, claims, and complaints.

In addition, the CCS specifically has the Insured Assistance Service (SAA), which has proven to be an ideal complement to the direct contact channels to deal with possible claims that raise matters in which the entity's services have already made a firm pronouncement.

The CCS also attends to face-to-face queries from insured persons or their representatives, both in the different offices of the territorial delegations and at its headquarters, although these are becoming less frequent because practically all procedures can be carried out electronically or by telephone.

 

Project interest: 

The extraordinary risk coverage system has been transforming and evolving with the Spanish insurance sector, society, and economy. It has been operating in a climatic environment such as ours, particularly complex and varied at the climatological level due to its geographical position between a temperate zone and a subtropical zone, an Atlantic marine area and a Mediterranean inland sea area. In addi ion, the presence of the Canary Islands adds even more variability to its area of action.

To date, the system has shown itself capable of dealing with the recorded claims, some of particular intensity and cost. However, the number of compensation requests has multiplied, and the average annual compensation cost has increased in recent years. However, it should be noted that the number of policies covered by the CCS has also multiplied greatly, maintaining the system's balance and capacity.

In this sense, the characteristic peculiarity of this system is its compulsory nature and universalization through a broad insured base, which provides the insured with an adequate degree of coverage against risks considered extraordinary.

The system is based on mandatory public-private cooperation by including extraordinary risk coverage in all policies relating to damage to property, life and accident insurance and possible loss of profits, freely contracted by policyholders with any insurance company.

By the above, the coverage of extraordinary risks in the Spanish system is based on two basic fundamental principles:

  • the principle of compensation and solidarity, which includes the compensation between risks, geographical location, treatment and temporary compensation
  • the principle of collaboration with the insurance activity in the management of the system

With regard to its cost, extraordinary coverage is not priced according to the level of exposure to a given risk but is calculated based on reaching an overall technical balance for all the risks covered by the system.  In any case, the surcharge depends on the type of protected asset and the capital insured in each policy.

On the other hand, the mandatory nature of this coverage extends to the entire group insured in the policies. This large extension of the insured base allows for very broad coverage at a very affordable cost for the insured. The system is self-sustaining and does not require any contribution from the budgets of any public administration.

Another strength of the system is its ability to adapt and be flexible, allowing it to evolve according to the needs of the insurance sector in Spain. It has faced challenges that have led to improvements in the coverage regime through the relevant legal amendments, including the incorporation of new risks (such as wind) and new lines (such as loss of profits and life, among others).

From an international perspective, the uniqueness of the CCS justifies the interest of different organisations or associations from different countries that cover risks related to the Consortium's areas of activity, with numerous consultations and visits from international delegations to learn about this Spanish extraordinary risk coverage model.

Success and limiting factors: 

The fundamental success of the Spanish system of coverage against extraordinary risks is the Consorcio de Compensación de Seguros (CCS) itself, created in 1954 after the merger of different consortia for the coverage of contingencies, developed to respond to the losses caused by the Civil War and other significant losses that occurred. Currently, the CCS has different areas of action (motor vehicle civil liability, combined agricultural insurance, environmental or nuclear risks, ...), standing out singularly for its coverage of extraordinary risks.

The CCS is thus the central figure of a unique compensation system for catastrophic damage based on its obligatory nature. This system provides policyholders with coverage against this type of risk through its inclusion in policies for damage to property, life, accidents, and pecuniary losses, which policyholders freely contract with any insurer.

This coverage is, therefore, universal in nature, compensated among the entire insured base, and priced to achieve an overall technical balance for all the risks covered by the system. The surcharge amount corresponding to each policy depends on the type of protected asset and the capital insured.

This allows for comprehensive coverage at a very affordable cost, which makes the system self-sustainable and does not require any contribution from the budgets of any public administration. To date, the system has been balanced, efficient and adequate in the face of supervening contingencies (some of particular intensity and cost), being flexible and sufficient to meet them with solvency. Although indemnities have grown significantly in recent years, the system has also grown in the number of policies and has maintained its balance and financial potential.

As a limitation, from the scope of action of the CCS, there is a need to evaluate the changes that occur due to climate change in terms of the risks it assumes, seeking solutions that allow them to continue to be assumed.

To this end, it is necessary to optimally understand the evolution of the hazard due to climate change (in particular due to flooding and strong winds) and consider possible technical insurance options in the long term, including adjustment of surcharges or coverage if the situation requires it.

Some risks that may be exacerbated by climate change, such as heat waves and pandemics, are currently covered by the insurance sector through life insurance in its ordinary coverage. If this magnitude increases sufficiently, the debate of including these risks within the extraordinary risk system could arise, although that moment seems distant for now.

Other limitations refer to the uncertainty and lack of precise models for a correct assessment of the risks derived from climate change, including possible scenarios that guarantee maximum coverage while maintaining the viability and stability of the model.

Climate change poses important changes to the insurance sector in three fundamental aspects: underwriting, investment strategies and the sector's environmental policies. Of these three elements, underwriting understood as the process of deciding whether a risk is insurable and under what conditions, is one of the most vulnerable aspects to the phenomenon of climate change within the framework of this insurance market.

In addition, information asymmetries between the insured and the insurer can lead to careless behaviour on the part of policyholders, exaggerating their confidence in insurance coverage (moral hazard) and causing changes in the severity and probability of claims. These behaviours are likely to be exacerbated in the face of extreme weather events.

This problem of asymmetric information, associated with the difficulty of identifying high or low-exposure risks through pricing, makes underwriting, in general, a costly process for insurance companies. In the particular case of the CCS, the automatic coverage and mutualisation of risk facilitate the universality and affordability of insurance protection. However, it does not explicitly encourage policyholders' adoption of self-protection measures.

The CCS studies measures that, beyond the dissemination and awareness-raising work carried out with the insurance sector and other institutions, impact positively prioritising this type of risk-reducing behaviour. The CCS will also support any measure to reduce exposure and vulnerability to risks, from regulation to territorial planning.

Budget, funding and additional benefits: 

The Insurance Compensation Consortium has its own assets and is different from the State. Its income is made up of premiums, surcharges, and the proceeds of its investments.

To deal with claims for coverage of extraordinary risks that may apply, the CCS has, like any other insurance company, a technical provisions fund by Royal Decree 2013/1997 of 26 December. This fund constitutes a stabilisation reserve, the real heritage of attention to this type of risk and catastrophe.

It is a financial mechanism for accumulating resources, which is nourished by the positive results of years with low claims, to deal with the claims rate of other years in which losses exceed income with a sufficient financial guarantee. This temporary compensation between years is required by the high loss potentially resulting from the risks covered, which are characterised by their low frequency and high severity and the irregularity of their materialisation. In this sense, the CCS maintains an adequate solvency margin with this mechanism. Although it is a public entity, it does not depend on the budgets of any Public Administration.

However, given the peculiar characteristics of this coverage and the very public nature of the CCS, the State, at its request to maintain the appropriate technical-financial balance for each branch of insurance and ensure compliance with the requirements established in the regulations on Solvency II (Directive 2009/138/EC of the European Parliament and of the Council,  of 25 November 2009), may make capital contributions that are included in the General Budget.

In any case, the last financial year of 2018 was marked by the reduction of the surcharge rate for the coverage of extraordinary risks to mitigate the evolution of its stabilisation reserve, the purpose of which is to compensate for unfavourable deviations in the loss rate. This reduction was 11% on damage to property, 40% on damage to people, and 28% on pecuniary losses.

At the end of 2018, the available stabilisation reserve (once the surpluses from the year had been incorporated) reached €9.596 M (€8.826 M in general activity and €770 M in agricultural activity).

On the other hand, the loss rate stood at 36.4% of premiums for these purposes, while the evolution was positive at 1.7%. In this regard, and as a guideline, the capital insured by the CCS in recent years is:

 

homes and residents’ associations 3 billion €
offices 94,000 million €
shops and other ordinary risks 454,000 million €
industrial 1 billion €
construction works 7,000 million €
people 9 billion €
Legal aspects: 

The Consorcio de Compensación de Seguros (CCS) 's coverage of extraordinary risks is affected by all the regulations and/or legislation that delimit and regulate it, as well as by those referring to the CCS itself and its management system.

In this regard, reference can be made to the Legal Statute of the Consorcio de Compensación de Seguros, which regulates and constitutes it, as well as, in particular, Royal Decree 2013/1997 of December 26, regulating the technical provisions to be provided by the Consorcio de Compensación de Seguros, of the Ministry of Economy and Finance.

At the level of extraordinary risks, the following regulatory documents should be noted:

- Royal Decree 300/2004, of February 20, approving the Regulations on extraordinary risk insurance and its subsequent amendments (Royal Decree 1265/2006, of November 8, Royal Decree 1386/2011, of October 14 and Royal Decree 1060/2015, of November 20). Rate of surcharges in Extraordinary Risks,  coverage clause to be inserted in ordinary insurance policies and information to be provided by insurance companies according to Resolution of November 27 2006, of the Directorate General of Insurance and Pension Funds (DGSFP) and subsequent amendments (Resolution of November 12 2008 and Resolution of May 31 2016)

- Rate of surcharges in Extraordinary Risks,  coverage clause to be inserted in ordinary insurance policies and information to be provided by insurance companies according to Resolution of March 28, 2018, of the DGSFP

- Deductions to be applied by the Consorcio de Compensación de Seguros in matters of extraordinary risk insurance

 

Implementation time: 

The Insurance Compensation Consortium (CCS) was created in 1954 and has been in operation ever since. Given the nature of this extraordinary risk coverage, its mandatory and automatic nature as a surcharge when taking out any policy, and its compensatory and self-sustainable nature through a broad insured base, its implementation and durability depend on the policies taken out by the insured in each case.

However, the CCS Board of Directors approves a strategic plan every three years that guides the entity's actions during this period, defining coverage, risks, indemnities, rates, and exclusions. The current PAT 2023-2025 came into force in January 2023.

Reference Information
Contact: 
  • Francisco Solano Espejo Gil

Deputy Director of Studies and International Relations

CCS - Insurance Compensation Consortium

Email: fespejo@consorseguros.es

Phone: 913395549

Sources: 
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